Low interest rates have raised the importance of dividend funds.
High-dividend mutual funds not only generate income, but can also lower risk in an investor’s portfolio. Dividend strategies are more important currently since interest rates are near zero, and generating income from bonds is a challenge, says Jodie Gunzberg, managing director, chief investment strategist, Morgan Stanley, Wealth Management Institutional. “During times of low interest rates, investors are pushed out on the risk spectrum and look to dividend-paying stocks as an income surrogate for what would have otherwise been dedicated to bonds and interest income,” she says. Dividend mutual funds are beneficial in this environment — with yield on bonds this low, dividend stocks provide a nice alternative to cash-generating securities, says Derek Horstmeyer, an associate finance professor at George Mason University. “With valuations in the stock market this lofty, dividend stocks provide some downside projection should we see a September or October contraction in equity markets,” he says.
Here are seven high-dividend mutual funds to consider for your portfolio.
T. Rowe Price Dividend Growth Fund (ticker: PRDGX)
The T. Rowe Price Dividend Growth Fund is a large-cap blend fund and has been handled by portfolio manager Thomas Huber since 2000. The fund’s top holdings are Microsoft Corp. (MSFT), Apple (AAPL) and Visa (V), while the top sectors include information technology, industrials and business services, health care and financials. The expense ratio is 0.62% — or $62 annually for every $10,000 invested — and the fund has most of its holdings in U.S. companies with only 2.9% in foreign stocks. Year to date, 63 S&P 500 companies have cut or suspended their dividend, wrote Cole Hunter, vice president of U.S. equity strategy at Goldman Sachs, in an Aug. 24 report. There have only been eight total cuts and suspensions during the past 2.5 months compared with 33 increases and initiations.
10-year return: 13.48%
Fidelity Equity Income Fund (FEQIX)
The Fidelity Equity Income Fund is a diversified domestic equity fund strategy that seeks to exceed the S&P 500’s yield. The fund has an expense ratio of 0.61%. The top four sectors in the fund are financials, health care, information technology and industrials; the top 10 holdings include Cisco Systems (CSCO), JPMorgan Chase & Co. (JPM) and Johnson & Johnson (JNJ). Ramona Persaud has been the portfolio manager since October 2011, and there is no minimum investment. Dividend payout ratios that are more than 60% are a red flag in this environment, so investors should stay in the 30%-60% range, says Michael Underhill, chief investment officer of Capital Innovations. “Beware of oil and gas energy sector dividend stocks, as there may be more carnage in that space.”
10-year return: 12.42%
Vanguard Real Estate ETF (VNQ)
The Vanguard Real Estate ETF invests in stocks issued by real estate investment trusts, or REITs, companies that purchase industrial and office buildings, hotels and other property. Specialized REITs make up 41.7%, industrial REITs 11.8% and health care REITs 8.3% of VNQ. Office REITs compose only 7.9% of the ETF. The top four holdings as of July 31 were the Vanguard Real Estate II Index Fund (VRTPX), American Tower (AMT), Prologis (PLD) and Crown Castle International (CCI). The expense ratio is 0.12%, and the fund generates a 3.77% dividend yield. Investors who seek only the highest dividend yields are not always using the best strategy, because an investor could overweight REITs, European stocks and oil companies, says Stuart Michelson, a finance professor at Stetson University in Florida. This could increase the risk of an investor’s portfolio.
10-year return: 9.7%
iShares Core Dividend Growth ETF (DGRO)
The iShares Core Dividend Growth ETF invests in companies that have a history of sustained dividend growth. The top four holdings are Apple, Microsoft, Johnson & Johnson and Verizon Communications (VZ). DGRO has an expense ratio of 0.08 and a 2.42% dividend yield. Many stocks have a policy of maintaining or growing a dividend that can adapt to the business environment, Gunzberg says. “To the extent a company raises their dividend over time, this introduces the concept of ‘yield on cost,’ where the investor’s dividend yield based on their cost basis is more attractive than the current yield. Stock investors may experience both price appreciation and growth of income.”
5-year return: 10.4%
Vanguard Utilities ETF (VPU)
The Vanguard Utilities ETF consists of 58.5% electric utility companies, 29.4% multiutilities and 4.7% water utility companies. The top three holdings are NextEra Energy (NEE), Dominion Energy (D) and Duke Energy Corp. (DUK). VPU has an expense ratio of 0.1%. Dividend strategies are generally useful for income generation and can be good diversifiers for growth stocks, Gunzberg says. “Fortunately, there are some potential benefits in using dividend strategies rather than bonds for income,” she says. “Many investors prefer the ‘bond proxy’ sectors like utilities and consumer staples for their relatively high yields, which generally pay a premium dividend yield versus the bond counterparts and have more price appreciation potential as a hedge against inflation.”
10-year return: 10.9%
Vanguard High Dividend Yield ETF (VYM)
The Vanguard High Dividend Yield ETF tracks the FTSE High Dividend Yield Index and is a passively managed ETF. The top holdings include Johnson & Johnson, Procter & Gamble Co. (PG) and JPMorgan Chase. This ETF holds 426 stocks, is broadly very diversified and emphasizes income. The expense ratio is low at 0.06%. The fund is rated at moderate to aggressive risk and is appropriate for investors with longer investment horizons. Dividend mutual funds and ETFs provide the benefit of dividend reinvestment, Michelson says. “When bond yields are low, dividend mutual funds investors will generally receive a higher return.”
10-year return: 12.12%
Fidelity Dividend Growth Fund (FDGFX)
The Fidelity Dividend Growth Fund invests in higher-quality stocks and is a large-cap diversified domestic equity fund. Gordon Scott started managing the portfolio in April 2017, although FDGFX is more than 25 years old. The dividend yield is 4.03%. The fund’s top holdings include Bank of America Corp. (BAC), Altria Group (MO) and Cisco. Dividend-paying equities complement fixed-income investments while providing the potential for capital appreciation, Underhill says. “Investors this year have benefited in dividend-paying technology stocks and will benefit for the foreseeable future,” he says.
10-year return: 21.19%
High-yield dividend funds:
— T. Rowe Price Dividend Growth Fund (PRDGX)
— Fidelity Equity Income Fund (FEQIX)
— Vanguard Real Estate ETF (VNQ)
— iShares Core Dividend Growth ETF (DGRO)
— Vanguard Utilities ETF (VPU)
— Vanguard High Dividend Yield ETF (VYM)
— Fidelity Dividend Growth Fund (FDGFX)
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