How $300 per Month Can Create $50,000 in Annual Dividend Income

Steadily building a portfolio of high-quality dividend payers could set you up for decades of passive income.

Ideally, you'll find companies that not only pay a solid dividend today but can pay bigger and bigger dividends over time. That should prevent you from having to sell your shares for extra income in retirement, and such stocks have historically outperformed the rest of the market too. Over the past 50 years, stocks that consistently raised their dividends produced a compound annual return more than one percentage point higher than stocks that merely paid a dividend but didn't raise it.

Luckily, building a portfolio of great stocks with the potential to continually raise their dividends doesn't have to be difficult. Just $300 per month invested in a single ETF could eventually produce a portfolio capable of paying out $50,000 in annual dividend income.

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The best dividend ETF to buy and hold

If you're going to devote years to establishing a position in a single ETF, it better be one of the best in the industry. For my money, there's no better dividend ETF for buy-and-hold investors than the Schwab U.S. Dividend Equity ETF(NYSEMKT: SCHD).

The fund tracks the Dow Jones U.S. Dividend 100 index, which selects 100 stocks issued by U.S. companies with 10-year-plus track records of paying dividends and who maintain the financial health needed to keep paying and raising those dividends for years to come. Those strict selection criteria result in a portfolio with much higher-quality companies, on average, than other ETFs focused exclusively on high dividend yields. A high yield isn't worth very much if the company paying it is forced to cut the dividend.

The 10 largest holdings (and their forward yields) in the Schwab ETF are:

• Home Depot (2.1%)
• Blackrock (2.0%)
• Cisco Systems (3%)
• Chevron (4.4%)
• Lockheed Martin (2.2%)
• Bristol Myers Squibb (4.5%)
• Verizon Communications (6.2%)
• Pfizer (5.7%)
• Texas Instruments (2.7%)
• Abbvie (3.2%)

As you can see, these top stocks all have above-average yields (the S&P 500 overall has a yield of 1.3%), but they don't all have super-high yields. Some of the biggest holdings have relatively modest yields with great potential for growth over time. That can result in a higher yield on your original investment over time versus picking the stocks with the best yield today.

Since the Schwab fund is an index fund, it sports a very low expense ratio. Investors pay just 0.06% of assets in annual fees, meaning the fund won't eat into your returns very much.

Building a portfolio that pays $50,000 in dividends, $300 at a time

If you invest $300 per month in the Schwab U.S. Dividend Equity ETF, you'll eventually find yourself with a sizable portfolio. Sticking with it for 40 years will likely result in a portfolio worth well in excess of $1 million. What's more, it's reasonable to expect that portfolio to pay out around $50,000 in dividends starting in year 41 with annual raises thereafter.

The ETF boasts a 13.4% annualized return since its inception in 2011. While dividend growers have historically outperformed the market, expecting those exceptional returns to continue for the next 40 years may be too ambitious. A 10% total return is in line with historical returns from large-cap value stocks like those found in the ETF.

The fund's 30-day yield of 3.6% may also need some adjusting. The Federal Reserve has just ended an historic rate-raising campaign. As rates come down, investors can expect more capital to move from lower-risk assets like Treasury bonds to stocks, which will result in lower dividend yields. The FOMC currently expects interest rates to settle about 2 percentage points lower than where they currently stand in the long run.

So, a yield of around 3% may be a more reasonable long-term expectation. Of course, that comes as a result of strong price appreciation for stocks, so you'll get a lower yield on a bigger portfolio.

Based on those assumptions, here's how a monthly investment of $300 in the Schwab U.S. Dividend Equity ETF will compound over time.

Calculations by author.

Importantly, the above table is merely a hypothetical based on one person's best guess for the average returns and yield you can expect from the Schwab ETF. However, the stock market rarely produces average returns year to year. Some years will see your portfolio soar, while others will see it crash. The sequence of those rises and falls could have a significant impact on the final value of your portfolio. The longer you invest, though, the more likely you'll see results closer to average.

It's also important to note that $50,000 in 40 years won't be worth as much as it's worth today. The reality of inflation became all too clear for many over the last few years. The slow and steady erosion of the value of a dollar may mean you need to supplement your dividend income with other sources of income or investments or continue investing for even longer.

With that in mind, the Schwab U.S. Dividend Equity ETF represents one of the easiest ways to build a diversified portfolio of quality dividend payers without having to pay high fees or spend hours researching individual companies.

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