Want Decades of Passive Income? Buy This Index Fund and Hold It Forever

Too many investors understate the importance of dividends. Sure, many retirees are already familiar with dividend stocks, especially those with high yields that can help investors pay their living expenses with passive income.

But dividend investing is a young person’s game, too.

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Stock prices fluctuate over time, but dividends keep stacking up. Dividends are real money in your pocket and aren’t lost once paid. Since 1940, dividends have contributed about 34% of the S&P 500‘s total returns. But reinvesting the dividends unlocks another level of compounding that can build immense wealth. Reinvested dividends account for 85% of the S&P 500’s total returns since 1960.

So, if you want decades of passive income that can snowball into generational wealth, you’ve got to see this. The following exchange-traded fund (ETF) is arguably the best building block around. Consider buying shares now and holding them forever.

The Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) is arguably the best dividend ETF you can buy. The first reason is the simplest. You’ve probably heard at some point that you shouldn’t put all your eggs in one basket. Perhaps the best thing about ETFs is that they automatically diversify your investments. ETFs are groups of stocks that trade on equity exchanges under one ticker symbol.

In this case, the Schwab U.S. Dividend Equity ETF, or SCHD for short, holds 103 individual stocks. The fund replicates and follows the Dow Jones U.S. Dividend 100 index. In other words, a share of SCHD means you own tiny pieces of these 103 individual companies.

To be more specific, the SCHD includes stocks across various industries, led by:

• Financials: 18.2%

• Healthcare: 15.8%

• Consumer staples: 14%

• Industrials: 13.4%

• Energy: 11.9%

The remaining industries represent less than 10% of the fund, including technology at just 8.8%. The fund’s top individual holdings include Bristol-Myers Squibb, BlackRock, Cisco Systems, Home Depot, Chevron, Texas Instruments, Lockheed Martin, Verizon, Amgen, and United Parcel Service (UPS).

No stock currently represents more than 4.55% of the fund, while the S&P 500 weighs Nvidia at more than 7% despite the index holding 500 companies. I would argue that the SCHD is more diversified than the S&P 500 today.

Reinvesting dividends can compound your passive income over time, like a snowball that grows larger as it rolls downhill. The math behind that snowball depends on a stock’s initial dividend yield and how quickly the dividend grows. Often, the higher the initial dividend yield, the less growth you get.

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Many retirees prefer high yields because they don’t want to wait years for dividend increases to pile up. Meanwhile, those with the time may look for faster-growing dividends, even if they don’t yield much. If companies can maintain enough growth, those dividends can eventually surpass today’s high yielders. You must adjust this sliding scale between yield and growth to your needs.

What I like about SCHD is that it does a great job balancing the two. Today, the fund yields just under 3.5%, which is relatively high compared to most stocks on the market. For comparison, the S&P 500 yields just 1.3%.

Yet, the dividend is growing, too. The fund’s dividend has increased by 174% during the past decade.

The Dow Jones U.S. Dividend 100 index, which as noted SCHD follows, uses a strict scoring system to select the stocks that go into the index based on several financial metrics. The index looks for financially healthy companies that generate a high return on equity and are raising their dividends. Then, it looks for the highest-yielding stocks among them.

It’s not perfect. The fund’s low exposure to technology has caused it to lag behind the S&P 500 since early last year. But overall, it’s proven to be a fantastic fund for those who want to increase their passive income via dividends over time. There is no glaring reason that would change anytime soon.

Before you buy stock in Schwab U.S. Dividend Equity ETF, consider this:

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Justin Pope has positions in Chevron. The Motley Fool has positions in and recommends Bristol Myers Squibb, Chevron, Cisco Systems, Home Depot, Nvidia, and Texas Instruments. The Motley Fool recommends Amgen, Lockheed Martin, United Parcel Service, and Verizon Communications. The Motley Fool has a disclosure policy.

Want Decades of Passive Income? Buy This Index Fund and Hold It Forever was originally published by The Motley Fool