So I was planning to have vanguards REIT and high yield dividend make up most of my roth. My 401k has a vanguard mutual fund that tries to mimick the sp500. Are the reit and high dividend yield etf best for my roth? or should I go with something like VOO or VTI? I figured the dividends would eventually be able to buy more shares since the roth is limited to how much you can put in each year. Thanks again for all the advice!
It sounds like you are falling into the "Dividends are magical" trap (my own term for it). Dividends are great, but they are no better than a stock increasing in price by the same amount (minor tax implications aside).
Quick lesson: Let's suppose there is publicly traded company called Driko's (stock symbol "D"). Dricko's generates a profit each year and is slowly growing. Management can decide to do a few things with those profits. It can return money directly to shareholders as a dividend, it can invest in the business (either R&D or growth expansion) or it can hoard money.
If it gives shareholders dividends = to profits than the stock price won't go up or down very much. If it chooses to expand its business than (hopefully) the share price will go up since profits will (hopefully) continue to increase.
All things being equal, the dividend paying stock will not go up as much each year because it has to pay out a large chunk of its profits to investors as dividends.
It gets a bit more complex because share price based on what people will pay now based on what they think it will be worth some point in the future - but the idea is pretty simple.
So - should you invest in an index or stocks that pay high dividends, or ones that will (hopefully) increase in share price? The real answer is: it doesn't matter. It's two sides of the same coin. All else being equal stocks that pay dividends will not see their share prices increase as much as stocks that don't. So - in order to live off your portfolio, you will either need to cash out the dividends, or sell some of your stock each year. Don't worry, stocks go up in price and they occasionally split, so as long as you don't take out too much each year you will never run out of stock to sell. Ideally what you sell should be "replaced" by increases in share price and dividends.
Back to your question regarding how we can plan on our investments earning 7%/year? This amount is based on the real-adjusted (i.e. factoring in inflation) returns of the SP500 index over the last 100 years. Pick any historical 30-year period you like, any one at all (e.g. Feb 1971 to Feb 2001) and the annual returns will be between 4.7% and 9.2%. The median annual return after inflation is just over 7%.
So if the median is ~7% after inflation, why don't we just choose to live off 7% withdraw rates (WRs)? The simple answer is volatility - even the median returns are 7%, there are bad years and good years, and if you start withdrawing 7% and have a few bad years up front, you'll run out of money. In fact, withdrawing 7% every year would leave you bankrupt almost two-thirds of the time over the last century. There was a rather elegant study done to test what the best withdraw rate is - fondly referred to simply as "The Trinity STudy" - and they found that a withdraw rate around 4% would be successful over 90% of the time. For that reason many choose to us the "4%-rule", although there are certainly lots of people who choose something even more conservative, while others are ok with a bit more risk.