This Simple Dividend ETF Could Turn $500 a Year Into $10,000

You don't have to start with a huge sum of money; you just have to keep saving hard month in and month out. That's really the key to long-term investment success. A good example of this comes from some simple math around Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD), starting with just a $500 investment. But it is a decade of commitment that turns that modest investment into a $10,000 cash hoard.

What does Schwab U.S. Dividend Equity ETF do?

Before getting into the math, it is important to understand what Schwab U.S. Dividend Equity ETF is all about. Dividend income is the quick answer, but how the exchange-traded fund (ETF) gets there is extremely important. The starting point is looking only at companies that have increased their dividends for a decade (eliminating real estate investment trusts, or REITs, which are designed to generate income and would likely sway the fund too heavily toward this asset class).

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The next step is to create a composite score that, basically, tries to ferret out a company's quality, growth, and income bonafides. The score includes cash flow to total debt, return on equity, dividend yield, and a company's five-year dividend growth rate. The 100 companies with the highest composite scores get into the index and are weighted by market cap. Although you might personally look at other metrics, the big goal is likely the same as if you were building a portfolio stock by stock: Buy good companies that pay reliable dividends.

All that work is handled by Schwab U.S. Dividend Equity ETF for a tiny expense ratio of 0.06%. The dividend yield is roughly 3.5%. The ETF was created in late 2011 and has a long history of success behind it, leading to an annualized performance of a very attractive 12% since its inception. Buying this ETF will leave you the freedom to focus on regularly saving money, where you are likely to have the biggest impact on your own long-term financial success.

What happens when you buy and compound?

If you invested $500 in Schwab U.S. Dividend Equity ETF and held it for a decade with a 12% annualized return over that span, you would end up with roughly $1,550. That's not a huge sum of money. But if you added $500 each year, you would end up with over $10,300.

You might argue that $500 a year over a decade is a lot more money. That's true; you will have put in the original $500 and then added $5,000 on top of it. The rest of the gain, roughly $4,800, was driven by the total return in Schwab U.S. Dividend Equity ETF over time. That's the power of compounding.

However, this is an income-focused investment, so there are really three factors working in your favor. First is the cash you save. The second is the returns of the stocks in the portfolio. And third is reinvesting the dividends created by the ETF's 3.5% dividend yield. If you are building your nest egg in preparation for retirement, these three combine to create a very powerful growth tool.

SCHD data by YCharts.

Don't underestimate the value of dividend reinvestment. As the chart above highlights, Schwab U.S. Dividend Equity ETF's price-only return over the past decade led to a doubling in the price of the ETF. But with dividend reinvestment, the value of the investment would have increased over 185%! That's a large and worthwhile turbo boost. The best part, however, is that you can turn that income stream on when you retire and collect those dividends.

SCHD data by YCharts.

That's not a small issue, either. As the chart above highlights, the dividends Schwab U.S. Dividend Equity ETF has paid have trended higher over time along with the price of the ETF. So, when you retire, the income you generate is likely to be larger than the income you would have collected at the outset of your investment plan.

There are no guarantees on Wall Street

As anyone who has been around Wall Street long enough knows, past performance is no guarantee of future returns. The numbers presented above are hypothetical and really just suggest the potential magnitude of the opportunity to invest regularly in an ETF like Schwab U.S. Dividend Equity ETF. But don't dismiss the example; take it to heart, if only directionally.

This ETF could easily help you build wealth over time, and all you have to do is focus on saving money. That's not an easy task, but it can, along with a decent ETF, truly change your life if you save hard enough for long enough.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.