Generating passive income can help investors cover everyday expenses and achieve their retirement goals. Accumulating assets like stocks and real estate can lead to gains, but some funds aim to reward investors with steady cash distributions.
These funds have relatively high yields and can be a reliable source of income. Income funds tend to be less volatile than funds that focus on growth stocks. The trade-off is that during a bull market, income funds may underperform growth-oriented funds. But the flip side is that income funds tend to have more resilience during bearish markets.
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Some of these funds also incorporate options trading to increase total payouts. Fund managers in charge of these accounts typically sell calls on their existing positions to realize cash flow. Options trading can limit the total gains from a position, but it can provide steady income. Also, income funds that incorporate options trading tend to have higher expense ratios and yields compared with other income funds.
What Are Income Funds?
Income funds give investors exposure to various dividend stocks, most of which have high dividend yields. Income funds can also contain bonds that provide stable income.
The Financial Industry Regulatory Authority, or FINRA, offers a definition for mutual funds that also applies to income funds in particular: “Each mutual fund has a different investment objective. Some funds invest in a particular product, such as stocks or bonds. Some focus on a particular industry or region. Others seek to replicate a market index.”
Since income funds focus on cash flow, many of the assets in these funds are blue-chip companies. Established household names tend to have less risk than up-and-coming growth stocks with frothy valuations.
Why Investors Buy Income Funds
These funds don’t generate the highest returns you can get, and the distributions are subject to tax. However, many investors buy income funds because they seek portfolio diversification and dividends. Investors looking toward retirement can use cash flow from these funds to cover some of their expenses.
If you aren’t retiring anytime soon, you can reinvest dividends back into the fund so that you end up with more shares. The more shares you have, the more cash you receive from each distribution. Accumulating shares now can give you more choices in retirement, especially if you combine your income funds with other income sources like Social Security.
While investors can benefit from allocating a percentage of their portfolio to income funds, it’s important to choose the right funds for your portfolio. These are some of the top income funds to consider, all of which have a balance of solid ratings, decent to high yield and good long-term returns:
| Income Fund | Expense ratio | Annual yield (TTM) |
| First Trust Morningstar Dividend Leaders Index ETF (ticker: FDL) | 0.45% | 4.5% |
| iShares Select Dividend ETF (DVY) | 0.38% | 3.7% |
| Nicholas Equity Income Fund (NSEIX) | 0.7% | 2% |
| Invesco High Yield Equity Dividend Achievers ETF (PEY) | 0.52% | 4.3% |
| Vanguard Equity Income Fund (VEIPX) | 0.28% | 2.7% |
| Vanguard High Dividend Yield ETF (VYM) | 0.06% | 3.1% |
| JPMorgan Equity Premium Income ETF (JEPI) | 0.35% | 10% |
| WisdomTree U.S. High Dividend Fund (DHS) | 0.38% | 4.2% |
First Trust Morningstar Dividend Leaders Index ETF (FDL)
First Trust Morningstar Dividend Leaders Index Fund has $4.3 billion in assets under management and an annual yield of 4.5%. The fund’s top three holdings are AbbVie Inc. (ABBV) (8.9%), Chevron Corp. (CVX) (8.7%) and Verizon Communications Inc. (VZ) (8.2%). The fund’s top three sectors are financials (22.4%), energy (18.9%) and health care (15.2%).
FDL has generated a total annualized return of 13.7% over the past three years as of Sept. 12, outperforming the Russell 1000 Value Index and the S&P 500 during that time. The fund currently has 101 holdings and gets rebalanced quarterly and reconstituted annually.
This fund excludes dividend-paying stocks that do not count as qualifying income, such as real estate investment trusts, or REITs. FDL has a 0.45% expense ratio.
iShares Select Dividend ETF (DVY)
The iShares Select Dividend ETF focuses on high-yield dividend stocks that have consistently paid their shareholders. The fund has 100 holdings, and the top three stocks are Altria Group Inc. (MO) (2.59%), Verizon (2.04%) and International Business Machines Corp. (IBM) (1.95%). The smaller weights for the top three positions indicate they have a lower impact on the fund than FDL’s top three holdings.
DVY has a 0.38% expense ratio and an annual dividend yield of 3.7%. The fund has $18.8 billion in assets under management and uses the Dow Jones U.S. Select Dividend Index as its benchmark. The fund’s annualized total return over the past three years is 14.2% as of Sept. 12.
The top three sectors represented by DVY’s holdings are utilities (26.2%), financials (24.1%) and consumer staples (9.4%).
Nicholas Equity Income Fund (NSEIX)
Nicholas Equity Income Fund has been around since 1993, with a $500 minimum initial investment and $436 million in assets. The fund focuses on dividend-paying stocks and is managed by Michael Shelton and David Nicholas.
The fund focuses on small- and mid-cap stocks and consists of 66 holdings. The top three sectors are health care (19.4%), financials (15.3%) and information technology (11.3%). The fund’s top three holdings are Microsoft Corp. (MSFT) (3%), Air Products and Chemicals Inc. (APD) (2.2%) and Medtronic PLC (MDT) (2.2%).
NSEIX has generated a total annualized return of 10.6% over the past three years as of Sept. 12, and the fund has a 0.7% expense ratio. Its 15-year return of over 10% beats both its category and its benchmark index.
Invesco High Yield Equity Dividend Achievers ETF (PEY)
Invesco High Yield Equity Dividend Achievers ETF has a trailing 12-month yield of 4.3% and uses the Nasdaq U.S. Dividend Achievers 50 Index as a benchmark. About 90% of the fund’s assets go toward dividend-paying stocks. The fund has a 0.52% expense ratio and has generated an annualized 15.7% return over the past three years as of Sept. 12.
The top three holdings of PEY are Telephone and Data Systems Inc. (TDS) (9.6%), VF Corp. (VFC) (3.7%) and Lincoln National Corp. (LNC) (3%). Almost half of the company’s total assets are in small-cap stocks, and the fund has more assets allocated toward mid-cap stocks than large-cap stocks.
Vanguard Equity Income Fund (VEIPX)
Vanguard funds are known for lower expense ratios than average, and this fund is no exception. Vanguard Equity Income Fund has a 0.28% expense ratio but requires a $3,000 minimum investment. The fund focuses on large value dividend stocks and has generated a 12.95% annualized return over the past three years as of Sept. 12.
VEIPX holds 194 stocks, and the top three holdings are JPMorgan Chase & Co. (JPM), Johnson & Johnson (JNJ) and Pfizer Inc. (PFE). The fund’s top three sectors are financials (20.6%), health care (15.2%) and consumer staples (14.1%). VEIPX has $47.5 billion in total net assets and a trailing 12-month yield of 2.7%.
Vanguard High Dividend Yield ETF (VYM)
Vanguard High Dividend Yield ETF focuses on large value stocks and has a 0.06% expense ratio. The fund has $49.5 billion in assets under management, spread across 463 holdings. The top three VYM holdings are JPMorgan Chase (3.3%), Johnson & Johnson (3.1%) and Exxon Mobil Corp. (XOM) (3.1%). The fund’s top three sectors are financials (20.4%), health care (12.3%) and consumer non-durables (11.5%).
VYM pays out a quarterly dividend and has an annual yield of 3.1%. The fund has a 12.8% annualized return over the past three years as of Sept. 12.
JPMorgan Equity Premium Income ETF (JEPI)
The JPMorgan Equity Premium Income ETF has a 0.35% expense ratio and a 10% trailing 12-month yield. The fund has $29.4 billion in assets under management that are spread across 117 holdings. The fund sells out-of-the-money call options to reward investors and generate distributable monthly income.
JEPI has generated an 11.1% annualized return over the past three years as of Sept. 12. The fund’s top three holdings are Amazon.com Inc. (AMZN) (1.8%), Adobe Inc. (ADBE) (1.7%) and Microsoft (1.6%). The fund’s top three sectors are information technology (14%), financials (11.5%) and consumer non-durables (10.7%).
WisdomTree U.S. High Dividend Fund (DHS)
WisdomTree U.S. High Dividend Fund has $1.2 billion in assets under management and a 0.38% expense ratio. The ETF has generated a 12.7% annualized return over the past three years as of Sept. 12.
DHS spreads its assets across high-yielding dividend companies in the U.S., and investors receive quarterly distributions from the fund. The top three holdings of DHS are Exxon Mobil (6%), Chevron (5.1%) and AbbVie (5%). The fund’s top three sectors are energy (21.4%), financials (18.4%) and utilities (12.6%). DHS has a 4.2% trailing 12-month yield.
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8 Top-Rated Income Funds originally appeared on usnews.com
Update 09/13/23: This story was published at an earlier date and has been updated with new information.
