How Index Funds Can Pay You Thousands in Retirement Income

Not saving enough or relying on a single income source in retirement are real problems for many people. While those who were fortunate to contribute to a 401(k) plan throughout their career can count on those savings to aid in retirement, for some, that alone may not be enough to live comfortably or maintain their current lifestyle.

One additional way to increase your retirement income is to focus on stocks that pay out dividends. When done the right way, there’s a chance to achieve thousands in monthly dividend income.

Focus on dividend stocks

Exchange-traded funds (ETFs) are index funds traded on stock exchanges just like regular stocks. Instead of purchasing various individual stocks to achieve diversification — one of the pillars of a good investing philosophy — you can simply invest in an index fund like the S&P 500, which tracks the 500 largest U.S. companies, and accomplish that with a single investment.

While many index funds have decent dividend yields as a byproduct of the fund’s companies, some index funds specifically focus on high dividend-paying companies. Take the iShares Core High Dividend ETF and SPDR Portfolio S&P 500 High Dividend ETF, for example. With dividend yields of 3.19% and 3.56%, respectively, the two funds consist of dividend-paying stocks that pay out higher-than-average yields.

Use dollar-cost averaging to build up your investments

Dollar-cost averaging involves making regular contributions to an investment, regardless of the stock’s price at the time. It’s similar to how a 401(k) plan operates; regardless of the price of your selected investment choices, you contribute a set percentage each paycheck. Over time, dollar-cost averaging is one of the best ways to amass a sizable investment total and take advantage of compound interest.

Let’s assume you’re able to save and invest for 30 years with an 8% annual return, a little bit less than the five-year average return of both of the index funds mentioned above. Here’s how much it would have accumulated at different monthly contribution amounts:

Monthly Contributions
Amount After 30 Years
$1,000
$1.35 million
$1,250
$1.69 million
$1,500
$2.03 million

Data source: author calculations

Now, let’s assume you made those contributions in either the iShares Core High Dividend ETF or SPDR Portfolio S&P 500 High Dividend ETF. Here’s how much the savings would pay out annually at their current dividend yields.

Account Value After 30 Years
HDV Annual Payout
SPYD Annual Payout
$1.35 million
$43,065
$48,060
$1.69 million
$53,911
$60,164
$2.03 million
$64,757

$72,268

Data source: author calculations. HDV = iShares Core High Dividend ETF. SPYD = SPDR Portfolio S&P 500 High Dividend ETF.

Even an index fund like the Vanguard High Dividend Yield ETF, which has a more modest 2.80% dividend yield, would pay out $28,000 annually with $1 million total invested. That’s more than $2,300 received monthly, and for those in retirement, this can be a beneficial way to complement other sources of retirement income, such as 401(k) withdrawals or Social Security benefits.

It pays to buy and hold

While there are great companies to invest in that don’t pay out dividends, making sure a portion of your investment portfolio consists of dividend-paying stocks can really fuel your investment savings over time. Market volatility is inevitable, but owning stocks that pay dividends ensures you make money regardless of what the market is doing.

You can purchase a dividend-paying stock for a certain amount, and if the stock’s price hasn’t increased at all years down the road, there’s still a chance you made money in that time due to the dividends. Reinvesting these dividends and letting compound interest work its magic is one of the best ways to accomplish your financial goals.

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Stefon Walters has no position in any of the stocks mentioned. The Motley Fool owns and recommends Vanguard High Dividend Yield ETF. The Motley Fool has a disclosure policy.