The Magic of High-Yield Index Fund Reinvestment

Index funds pay an embarrassingly low amount of dividends. However, they are a great product to dollar-cost average over a long time because it’s hard to beat their gains.

The problem arises when you need to generate income from your index funds in your working or retirement years.

Most people cannot live on a 1.5% dividend yield. If you had $1 million in index funds, the yield would pay you $15,000 annually—not enough to survive.

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High-yield reinvestment. But what if you reinvested those dividends at a higher yield during the accumulation phase?

The ultimate goal would be to create a hefty amount of supplemental dividend income from high-yielding products, so you wouldn’t need to sell your index funds (or at least sell much fewer).

I discussed the same method in my articles “High-Yield Bond Reinvestment” and “High-Yield Bond Reinvestment in Action.”

Let’s run the numbers to see if high-yield dividend reinvestment makes sense over 20-30 years and what benefits it can give us (if any). Let’s begin.

Running some scenarios. My math will be very rudimentary because calculating two diverging and compounding timelines is beyond my scope of calculations.

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Let’s use the Dow Jones Industrial Average Index Funds (DIA) as our example. It pays the highest yield (2%) out of my four favorite index funds (QQQ– 0.5%, SPY– 1.5%, VTI– 1.5%).

We have $100,000 in DIA, which pays us $2,000 in dividends annually. We receive 9% returns annually over 30 years by reinvesting dividends into DIA. 

This would give us $1.3 million and pay us $19,500 in annual dividends. Not too shabby for investing in a relatively safe index fund.

Let’s divide our growth and dividends. Now, using simple math, I will separate the DIA’s growth from its dividends. That’s 7% growth and 2% dividends.

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Over 30 years, the growth element will morph into $761,225. The dividend portion would turn into $181,000.

However, let’s say we were reinvesting the dividends into PIMCO High Dynamic Fund (PDI), a closed-end fund that yields 11%.

Over the years, these numbers would be compounding exponentially. But, I will use 11% of $181,000 for this example.

This gives us an annual dividend payout of $20,000. It may seem similar because I am using simple math. However, it would be closer to the difference between the growth numbers ($1.3 million versus $761,225).

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The nitty gritty. The difference between those numbers is $538,000. If you invest that at 11%, your annual dividend payout would be $59,000. Now, that’s something to write home about.

Don’t get caught in the numbers. Dividend investing isn’t truly about the numbers; it is a lifestyle. You would use high-yield index fund investing to improve your quality of life.

Index funds are the simplest way to jump into the stock market and capture its gains over the years. Most people go all in when passive index fund investing. 

However, when they retire, the 1.5% yield doesn’t do much for their lifestyle. They must sell shares to generate enough income to thrive in retirement. 

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I personally never want to sell shares. The 60/40 and 4% rules tell us that the market will gain 9-10% a year, so we can extract 4% a year and never run out of money.

But, when the market has a downturn, you risk selling more shares to generate the same income. It can lead to a sequence of return risks, which can destroy your wealth during retirement.

Start your own sub-portfolio. The idea behind high-yield index fund reinvestment is to create your own sub-portfolio that can supplement your lifestyle.

The numbers won’t be huge, but they can give you enough income to survive and thrive in retirement. If you combine it with renting rooms or selling fruits from your garden, you could do very well.

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Let’s say you went hardcore into index funds for 20 years and now have $300,000 in DIA. You would receive $6,000 in annual dividends.

Instead of reinvesting one year, you convert that $6,000 into Eagle Point Credit (ECC), a closed-end fund that invests in CLO securities and yields 15%.

Your ECC investment would pay you $75 per month. That is a fair amount of income. If you took the same steps for the next five years, your ECC investments would pay you $375.

Then, you can start reinvesting back into DIA, and your ECC investments would take a life of their own.

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I use both methods. I have a Total Market Index Fund (VTI) in all five of my portfolios. In my Wells Fargo and M1 Finance, I reinvest in higher-yielding products.

My Charles Schwab and STASH reinvest VTI back into itself. And I take my Cash APP dividends as cash to spend and enjoy.

This article is to show you that you can have it your way. I have received roughly $313 in dividends from VTI over the last three years.

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This is not much cash, but how many people can say they have received dividends? And that is the main point of high-yield dividend reinvestment—to keep your money safe.

Conclusion. Most people are risk averse, meaning they do not want to take undue risks. With high-yield bond and index fund reinvesting, you are keeping your principal safe.

You can take the interest and dividends and start your income-investing portfolio feeling secure that your original money is entirely safe (Treasury Bonds) or reasonably safe (Index Funds).

From Dirt to Dividends 5: Composting & Dividend ETFs

I like to call it “playing with house money.” I started my investing career by investing in dividend growth stocks but quickly discovered I love income investing much more.

You may be on the fence about anything dealing with the stock market, so you must go with what works. If you are trying to convert from a saver to an investor, index funds are the way to go.

Eventually, once you feel more confident, you can take some paltry dividends and start a little rouge portfolio of high-yielding products. You may enjoy it enough to build a more extensive risk profile (like me). Good Luck!

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