For passive investors, investing in individual stocks may not be enjoyable nor worth the time commitment. Although if you picked all high-performing stocks that can provide multiple return folds, you're likely going to have some duds that will bring down the returns. Additionally, in the long term, some companies may fail and be replaced by new companies. So not actively managing your portfolio can be detrimental. For those who want to invest for the long term without having to actively monitor the stock market, investing in index funds may be a good option.
Index Fund vs. Mutual Fund (actively managed)
An index fund can be purchased as either a Mutual fund or as an Exchange-Traded Fund (ETF), and it comprises the entire stock market index such as S&P 500, Nasdaq, or Dow Jones. The benefit of investing in the index fund is diversification and a low-expense ratio. These funds buy every firm listed on an index to mirror the performance of an entire stock market mechanically. As these are passively managed to follow the index, the cost of owning these funds has lower fee than owning actively managed funds that try to beat the market.
Cost of Investing
For example, $10,000 invested in an index fund with an expense ratio of 0.06% would cost you $6/year, versus an actively managed mutual fund will cost you $47/year. In the long run, these fees can significantly eat up the returns as you will likely have a higher balance and the fee is paid annually.
Pros and Cons of Index Funds vs. Mutual Funds (actively managed)
Index Funds (Passively Managed ETF/MF) | Actively Managed Mutual Funds or ETFs |
Diversification | Actively Selected |
Low Cost | High Cost |
Strong Long-Term Returns | Supposed to beat the market but not guaranteed |
Examples of Index Funds
Name | Ticker | Expense Ratio (per $10K) | Type of Fund |
Vanguard S&P 500 ETF | VOO | 0.03% / $3 annually | ETF |
Schwab S&P 500 Index Fund | SWPPX | 0.02% / $2 | Mutual Fund |
Invesco QQQ Trust ETF | QQQ | 0.20% / $20 | ETF |
Vanguard Russell 2000 ETF | VTWO | 0.10% / $10 | ETF |
SPDR Dow Jones Industrial Average ETF Trust | DIA | 0.16% / $16 | ETF |
Other Index Funds Include:
High-Yield ETFs
Now that you know the difference between an Index Fund versus an actively managed Mutual Fund and an ETF, below are some of the popular ETFs that pay high dividends.
Name | Ticker | Expense Ratio / Dividend Yield | Description |
Schwab U.S. Dividend Equity ETF | SCHD / $77.55 | 0.06% ($6) / 3.4% ($340) | 100 largest stocks that pay above avg. div for 10+ years (Merck, IBM, HD) |
SPDR Portfolio S&P 500 High Dividend ETF | SPYD / $40.99 | 0.07% ($7) / 4.1% ($410) | S&P 500 + 15% of highest dividend (fin, utilities, real estate) |
Global X Super Dividend ETF | SDIV / $8.36 | 0.58% ($58) / 15.7% ($1,570) | Finds largest div including international. Some can go under; high risk |
iShares Intl. Select Dividend ETF | IDV / $26.69 | 0.49% ($49) / 8.1% ($810) | Leaders in home countries with over 5%; can diversify from U.S holdings |
Building a High-Yield Dividend Portfolio
Dividend investing is a form of passive income investing where you receive a steady income stream from your investment portfolio. With a portfolio of various dividend-paying stocks and high-yield ETFs, you can utilize the dividend payment as part of your passive income stream.
For example, in a dividend portfolio with an average dividend yield of 3% in a $100,000 portfolio, you would receive an annual dividend return of $3,000, or $250/month. As you utilize dividend reinvestment (DRIPs) rather than cashing them out and with the power of compound investing to build your portfolio consistently, you can build a significantly sized portfolio that can generate a sizable monthly payment.
Our goal is to generate $1,000/mo in passive income by the time we reach FIRE. I want to build two portfolios: 1) a growth portfolio where we can withdraw a safe four percent and, 2) a dividend portfolio where we can receive roughly three percent in dividends.
Growth Portfolio (withdrawal of 4%):
Portfolio Balance x Withdraw rate = Annual Withdraw Amount
$225,000 x 4% = $9,000 ($750/mo)
Dividend Portfolio (dividend of 3%):
Portfolio Balance x Avg. Dividend Yield = Annual Return
$100,000 x 3% = $3,000 ($250/mo)
Yields between 2% to 6% are generally considered to be a good dividend yield. Generally speaking, older, larger companies that are well established and have a steady performance are more likely to pay dividends without having baggage compared to newer, smaller companies. As for some companies, a high yield could be due to artificially trying to boost dividends to attract investors for a troubled company or a falling stock price. Investors who want to invest in dependable, sustainable dividend stocks, are called "Dividend Aristocrats" that have increased their annual dividend payment for at least 25 years.
Looking at my main portfolio, we are forecasted to receive $345 in dividend income this year which comes out to $28.76/month. However, this portfolio comprises growth companies like technology sectors that typically do not pay dividends but investors can benefit from stock price appreciation. I am planning on building a separate dividend portfolio focusing on income investing (read: Building a Dividend Portfolio from Scratch).
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