Retiring on Dividends 106: Income Investing (Dividend ETFs)

The world is full of choices, especially regarding dividend-paying stocks. How can the average investor choose from so many great companies?

One way to collect a bucket full of companies is to purchase index funds. The S&P 500 Index Fund (SPY) collects 500 of the US’s top companies.

However, the yield on SPY is relatively low (1.5%). To generate $60,000 in annual dividends, you would need to invest $4 million. No, we need something with a little more pizazz—a dividend ETF.

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Welcome to the Retiring on Dividends series (101, 102, 103, 104, 105), where we work to get the best results during retirement.

The magic of Dividend ETFs. A Dividend Exchange-Traded Fund (ETF) assembles some of the best dividend-paying companies from the United States.

Because Dividend ETFs focus on dividend stocks, they exclude growth stocks like Palatir (PLTR), Amazon (AMZN), Tesla (TSLA), and Nvidia (NVDA).

This composition may lower the growth of the Dividend ETF vs an index fund, but it increases the yield, and we need higher yields for retirement.

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The magic of a Dividend ETF is that it takes all of the guesswork out of dividend growth investing (DGI). The Dividend ETF automatically invests across different sectors and asset classes.

My favorite Dividend ETF is the Schwab U.S. Dividend Equity ETF (SCHD). SCHD’s top ten holdings include some of my favorite dividend stocks of all time, including Abbvie (ABBV), Pfizer (PFE), Coca-Cola (KO), Cisco (CSCO), and Chevron (CVX).

You can simply dollar-cost average your way into SCHD for 20 to 30 years. This will do all the dividend growth investing for you.

Another great Dividend ETF is the WisdomTree U.S. High Dividend Fund (DHS). Some of my favorite companies in its top ten are Exxon Mobil (XOM), Altria (MO), and Philip Morris (PM).

By combining two or more Dividend ETFs, you will get a different collection of dividend-paying stocks and, therefore, different market results. Diversity is good.

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Alone and unafraid. But can you purchase only Dividend ETFs as your sole retirement plan? I wouldn’t recommend it because the yields are too low for a serious retiree. But let’s take a look.

The current yield for DHS is 3.74%, and SCHD is 3.43%. Let’s invest a million dollars in each and see how much income they generate.

With $1 million invested, SCHD would pay $34,300 in annual dividends, which is $2,858 monthly. DHS would pay $37,400 annually or $3,116 monthly.

This is a reasonable sum of money, but investing $1 million in the closed-end fund PDI would net you $140,000 annually or $11,666 monthly.

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However, one of the best reasons to invest in a Dividend ETF is for dividend growth. This means the speed at which the ETF increases the dividend annually. 

SCHD’s dividend compound annual growth rate (CAGR) is 11%. This means they have increased dividend payments by 11% yearly for the last five years.

For example, in June 2019, the dividend payment was $0.42. In June 2024, it was $0.82. That’s a massive increase for not having to do anything extra on your side.

If SCHD kept its dividend CAGR at 11% for twenty years, it would give you $276,537 in annual dividends (starting from $34,300).

Therefore, you invest in a Dividend ETF for future dividend growth, not current income. You want to start investing in SCHD and DHS in your 30s and 40s to harvest the income in your 70s and 80s.

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Dividend ETFs as a growth vehicle. How do Dividend ETFs compare to index funds? Most people who invest in index funds will sell shares to generate income during retirement.

We want to avoid selling shares at all costs, but we love the growth that index funds provide. Dividend ETFs can provide similar growth without having to sell shares in the future.

Keep in mind that most of the growth inside the Nasdaq (QQQ) comes from high-flying stocks that don’t pay dividends, like Nvidia (NVDA).

We cannot replicate that growth with a Dividend ETF because most dividend stocks are not high-flyers. However, we are compounding our dividend growth rate, which will help our retirement more.

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Ideally, you would layer on index funds and Dividend ETFs to leverage income and capital preservation.

You simply cannot stay rich if you sell shares to generate income. That’s bad business. The better approach is to continue adding shares until your last days.

Getting started with Dividend ETFs. The best way to get started with Dividend ETFs is to purchase a large allocation of them and let them get to work.

For instance, if you get a bonus, inheritance, or gift, use it to purchase a Dividend ETF. This starts the power of compounding as early as possible.

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You get the best results of Dividend ETF investing in the future. Once you drop your money into the Dividend ETF, you can let the four dividend growth investing principles do their work.

The four principles of dividend growth investing are dollar-cost averaging, dividend reinvestment, share price appreciation, and dividend raises.

The sooner you get a large lump sum into SCHD or DHS, the faster these four principles work in your favor. Remember, the end goal is to turn off dividend reinvestment during retirement and have a large stream of income arriving in your accounts.

You can purchase Dividend ETFs everywhere, especially SCHD. I have it on my Charles Schwab, M1 Finance, and STASH platforms. 

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Dividend ETFs for the win! There isn’t much to say about Dividend ETFs because they are super simple. You put your money in and let the passive index do the work for you.

If you don’t want to choose individual stocks but want a high income, this is the best path for you. However, I recommend adding some closed-end funds for retirement.

You should be good if you can get $1 million into SCHD in your 30s or 40s. For most of us, we will want to layer in some higher-yielding products for increased cash flow.

Conclusion. Dividend ETFs give us yield and growth, but their primary benefits are diversity and dividend growth. We get the best results when we let them work for 20 or 30 years.

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If you have time on your side, a Dividend ETF can serve you quite well. If you are a little advanced in years, you’ll want to add some closed-end funds with Dividend ETFs to get current and future income.

I love adding more SCHD and DHS to my portfolios. They serve me well, and DHS is a monthly payer. I have twenty years before I reach 63, so I have many years of growth.

I will make it a point to invest as much money as possible in SCHD to follow its dividend growth in my portfolio. 

If you love dividend-paying stocks, you have come to the right place. Dividend ETFs can preserve capital while giving you a massive hit of diversity. It’s a win-win, Good Luck!

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