This No-Brainer ETF Can Turn $500 Per Month Into $20,000 in Annual Dividend Income

Key Points

• This ETF tracks an index with strict selection criteria for companies paying a dividend.

• The focus on long track records and strong balance sheets ensures these stocks will keep raising dividends for years to come.

• Investing $500 per month and reinvesting the dividends could produce a sizable portfolio by the time you retire.

• 10 stocks we like better than Schwab U.S. Dividend Equity ETF ›

Building a portfolio of dividend stocks that can pay out thousands of dollars per year in passive income doesn't have to be difficult. A single exchange-trade fund (ETF) can handle all the difficult bits of selecting quality dividend-payers with potential to increase payouts every year. And if you invest part of your paycheck into it every month, you could amass a portfolio paying out over $20,000 in annual dividend income by the time you retire.

Not all dividend ETFs are created equal, though. Some simply select the highest-yield dividend stocks from a certain index. Others charge an arm and a leg for a fund manager to ensure you only buy the highest-quality dividend stocks. But the Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) offers quality stocks with a low expense ratio.

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Here's how investing $500 per month into the Schwab ETF could generate $20,000 in annual dividends for your portfolio.

Image source: Getty Images.

A best-of-breed dividend fund

The Schwab U.S. Dividend Equity ETF is an index fund, tracking the Dow Jones US Dividend 100 index. As the name implies, the index contains 100 stocks admitted by a selection committee based on a track record of paying dividends for at least 10 years and that have the financial wherewithal to continue paying (and raising) that dividend for years to come. That means that every member of the index is a quality company with a healthy balance sheet, not just some stock that's offering a high yield because the stock has been beaten down and it's in danger of seeing a dividend cut.

The top holdings in the ETF (and their dividend yields) are:

1. Abbvie (3%)
2. Chevron (4.3%)
3. Home Depot (2.2%)
4. Altria (6.5%)
5. ConocoPhillips (3.3%)
6. PepsiCo (4.1%)
7. Cisco Systems (2.5%)
8. Merck (4%)
9. Verizon Communications (6.3%)
10. Lockheed Martin (2.8%)

As you can see, the top holdings sport relatively high dividend yields, but not necessarily the highest in the market. Balancing quality companies with expectations for future dividend growth with current yield produces a strong portfolio well-positioned for excellent total returns. The ETF tilts toward value stocks, and it currently sports a price-earnings ratio of just 18 compared to a P/E ratio exceeding 25 for the S&P 500.

And since all the Schwab fund does is track an index, somebody else does the hard work of stock selection. Schwab passes those savings onto investors, charging an expense ratio of just 0.06%.

How $500 per month can turn into $20,000 in annual dividends

If you consistently invest $500 per month into the Schwab U.S. Dividend Equity ETF within a tax-protected retirement account, you'll eventually find yourself sitting on a sizable portfolio by the time you retire. Importantly, a retirement account allows you to reinvest your quarterly dividend distributions from the fund without incurring any tax liability.

Since its inception in 2011, the ETF has produced compound annual total returns of 12.6%. That's a phenomenal return for any investment, but it may be overstating the potential growth of your portfolio. Vanguard analysts expect U.S. large-cap value stocks to return an average of 5.5% to 7.5% per year over the next 30 years. Some may argue that's too conservative. Still, an annual return of 7% can create a big dividend stream over 30 years.

With a dividend yield of around 3.7%, here's an estimate of what your portfolio could look like over a 30-year investment horizon if you simply invest $500 per month into the Schwab ETF.

Table source: author. Calculations by author.

There are some important caveats to the table above. First and foremost, it's based on expected returns. Anyone who's invested in the stock market for even a minute knows stocks don't go up in a straight line. There will be great years and there will be not-so-great years. Your actual returns will vary considerably.

Moreover, stronger or weaker returns could impact the terminal value of your portfolio. That said, the dividend income it throws off might not be as dissimilar. That's because yields will decrease if stocks outperform, and they may climb if they underperform. That's especially true as the index selects stocks with strong balance sheets that can continue increasing their dividends over time.

Lastly, it's important to consider the impact of inflation -- $20,000 today isn't worth what it was 30 years ago, and it'll be worth even less 30 years from now. If you want your purchasing power to climb along with inflation, consider increasing your monthly contribution each year to boost your final portfolio balance.

While your results might not look exactly like the table above, for investors looking for the simplest path to building a portfolio paying out thousands of dollars in annual dividends, the Schwab U.S. Dividend Equity ETF is a no-brainer.

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Adam Levy has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends AbbVie, Chevron, Cisco Systems, Home Depot, and Merck. The Motley Fool recommends Lockheed Martin and Verizon Communications. The Motley Fool has a disclosure policy.