Investing in dividend stocks can be a fantastic way to generate passive income through the stock market, and a dividend ETF can make the process even more hands-off.
A dividend ETF is a collection of dividend stocks grouped into a single investment, and this type of investment can take much of the guesswork out of where to buy. Rather than having to research dozens of individual stocks, you can build a well-diversified portfolio with just one or two ETFs.
It takes time and consistency to generate a substantial amount of passive income with dividend stocks, but it's possible to create a $5,000-per-year income stream with minimal effort. Here's how.
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A powerful, yet safer, dividend ETF
Whether you're just getting started with dividend stocks or you're looking to add a solid ETF to your portfolio, the Vanguard Dividend Appreciation ETF (VIG 0.32%) can be a smart choice.
One major advantage of this fund is its diversification. It contains 338 large-cap stocks that are fairly evenly allocated across 10 industries. It's most heavily weighted toward tech, with around 23% of the fund made up of tech stocks. By comparison, the Vanguard S&P 500 ETF (which tracks the S&P 500 itself), devotes around 30% of the fund to the tech industry.
Greater diversification and less reliance on tech stocks can help limit your risk, especially during periods of volatility. Because this fund is relatively evenly spread across many industries, your investment won't be hit as hard if one or two sectors take a turn for the worse.
Building a passive income stream
The biggest perk of investing in dividend stocks is the passive income you'll receive in addition to your investment earnings. You'll earn a small amount in dividends per share, so the more shares you own, the more you'll receive in passive income.
The Vanguard Dividend Appreciation ETF most recently paid a dividend of around $0.94 per share per quarter, which would add up to $3.76 per year. That may not sound like much, but again, that's the dividend per share. The more you own, the more you'll earn.
To see how many shares it would take to reach $5,000 per year in dividends, we'll need to divide $5,000 by $3.76 for a result of around 1,330 shares. With this ETF currently priced at just under $200 per share, 1,330 shares would add up to an initial investment of around $266,000.
Investing that much cash at once is wildly out of reach for the average investor, but there's good news: You can also invest smaller amounts over time. For example, say that you can afford to buy three shares per month, or 36 per year. At that rate, it would take around 37 years to accumulate 1,330 shares in total.
Keep in mind, though, that these calculations assume the dividend payment remains the same over those 37 years. This ETF has a long history of increasing its dividend year over year, which means it may not take quite that long to accumulate $5,000 in annual dividend payments.
Dividends are only part of the equation
Remember, too, that any dividends you receive are in addition to whatever you're earning in investment gains. Over the past 10 years, this ETF has earned an average rate of return of 11.5% per year.
At that rate, if you were buying three shares per month for a total of $600 per month, you could accumulate around $3.5 million after 37 years -- on top of the $5,000 per year in passive income you'd be receiving from dividends.
You also don't need to spend $600 per month or invest for 37 years to see substantial gains. Even a small fraction of those contributions could still add up to hundreds of thousands of dollars, in addition to the quarterly dividend payments.
Investing in a dividend ETF is a fantastic way to build wealth while also generating passive income, and the Vanguard Dividend Appreciation ETF can supercharge your earnings while minimizing risk. The sooner you get started investing, the more you can potentially earn over time.
