A friend of mine mentioned making money faster from the stock market by investing in high dividend mutual funds. The idea is that these funds target companies that shell out returns to their investors in the form of cold hard cash. In the finance world these types of returns are called dividends. Dividends can be an effective source of supplementary income since they generate cash, but typically experience less capitals gains. If you own a slice of a company that pays out dividends you can expect to receive monthly, quarterly, or yearly dividends that can be received as cash, additional shares, or some other property.

High dividend mutual funds can boast returns that significantly out perform even the S&P 500! After hearing about them I had to research them more. Are they really worth the money? And if they’re such a good investment why hasn’t everyone bought into them?

Pros and cons of high dividend mutual funds

Dividend mutual funds are typically used for retired investors who are looking to continue making money into retirement or economic environments where bonds and bond funds are weaker. The reason for this is when interest rates are low and the economy is strong, bonds tend to have lower yields. This makes dividends a more attractive prospect since they can generate more income. These types of environments are ideal for dividend mutual funds because they they maintain higher yields without the aggressive position of growth, small cap or similar types of funds. Keep in mind that dividend funds still have a chance of losing principal since they’re composed of stocks. For younger investors interested in pure capital appreciation, it’s generally considered better to stick with growth stocks instead of dabbling into dividends to get their best bang for buck.

There are two main reasons why investors would want to stay away from dividend funds. If a company has enough cash for dividends it could mean decision makers within the company believe there aren’t good enough opportunities to make an solid return on investment. They return the cash to shareholders in the meantime so they can figure out what to do with it next. By definition this makes high dividend stocks only useful for their income generation instead of their growth in stock value.

Tax consequences are another reason to avoid dipping your toes into dividend funds. Holding a stock that grows in value is how typical capital accumulation operates and is one way to grow wealth. Much like traditional IRA’s that gain isn’t taxed until after the stock is sold. The value is kept within the investment and allowed to grow and compound. On the otherhand, dividend stocks creates a cash flow that’s taxed due to their income-generating nature. Reinvesting those dividends would be doing so on an after-tax basis. If your goal is to keep taxes to a minimum you’re better off holding onto growth stocks where the value will grow and be taxed on exit.

Five High-Dividend Mutual Funds to Consider

Everyone has a different investment portfolio that suits their own style, but I’ve compiled a list of five dividend funds to consider. These funds were selected based on their historic returns, reputation amongst other investors, and quality of investments. By no means this is an exhaustive list of “viable” dividend funds.

Fund Expense Ratio Yield
Vanguard High Dividend Yield Index Fund (VHDYX) 0.15% 2.85%
Fidelity Equity Income Fund (FEIKX) 0.51% 2.4%
Columbia Dividend Opportunity Fund (CDOYX) 0.62% 3.8%
Vanguard Dividend Appreciation Index Fund (VDAIX) 0.17% 1.98%
Vanguard Utilities Index Fund (VUIAX) 0.10% 3.4%
  1. Vanguard High Dividend Yield Index Fund (VHDYX) - Boasting an expense ratio of 0.15% this fund attempts to follow the FTSE High Dividend Yield Index. It takes large U.S. companies except for real estate trusts and companies that don’t pay out dividends, ranks each company according to their yield, and then takes a slice of all the companies that make 50% of the total dividends on the list. The end result is a fund that consists mostly of large cap companies that have a consistent history of paying out dividends. The VHDYX has a reputation for being an industry standard amongst high-dividend mutual funds.

  2. Fidelity Equity Income Fund (FEIKX) - With an expense ratio of 0.51% and a yield of 2.4%, the Fidelity Equity Income Fund uses the Russell 3000 Value Index for its benchmark. Its goal is to generate above-average yields and roughly maintain lower volatility compared to the market. While it has an expense ratio lower when compared with actively managed funds, it brings a return of 2.4% which brings it closer to the realm of bonds and CD’s.

  3. Columbia Dividend Opportunity Fund (CDOYX) - This fund carries whopping a expense ratio of 0.62% but a solid yield of 3.8%. That’s a return nearly double that of the S&P 500. It’s compromised of companies with solid dividend histories, the ability to grow their dividends, and the capability of freeing up cash flow generation. At its base the fund consists of high-yield blue-chip companies. Companies with the largest holdings consist of Philip Morris International, AT&T, and Altria Group Inc that compromise just over 16% of the fund. Over the past 10 years the fund has kept pace with the S&P 500.

  4. Vanguard Dividend Appreciation Index Fund (VDAIX) - VDAIX is an index fund and carries an appropriately low expense ratio of 0.17%. While it has the lowest TTM yield settling at 1.98%, its minimum investment is a relatively affordable $3,000. The index is designed to track companies that have raised their dividends in the past 10 years, which leads to an end result heavy on consumer-defensive and industrial names. By selecting companies with an extensive history of paying out dividends investors can be assured to a certain degree that they’ll receive dividends.

  5. Vanguard Utilities Index Fund - (VUIAX) - With a fractional expense ratio of 0.10% and a solid 3.4% dividend yield on paper this fund appears to be a fantastic buy. I’ve listed this last because Vanguard has a tier for investors with larger accounts called admiral shares. Purchasing admiral shares from VUIAX requires a minimum $100,000 investment but are well worth the money considering the expense ratio and yield. Utilities and REITs (Real Estate Investment Trusts) are traditionally considered to be dividend-rich sectors. Despite the attractive return, the Vanguard Utilities Index Fund is considered a sector pick and undiversified because it focuses on industries that pay the highest yields. Due to their nature they may perform in unexpected ways. Back in 2014 the S&P experienced a boom of more than 32%, yet Vanguard’s VUAIX fund experienced a relatively marginal 15% boost. Similar to how you wouldn’t put all of your money into healthcare of biotechnology, placing all of your funds into utilities is also a risky choice.

Keep In Mind

While dividends can become a a nice form of income, regular payments that are distributed to shareholders take money out of a company’s available capital. Businesses generally pay out dividends if they can afford the excess cash flow and don’t believe it’s worth reinvesting the money in themselves.

On the upside, dividend payments play with the power of compounding. For a company to maintain a dividend over an extended period of time generally requires steady standing with a good earnings quality. Businesses that return cash to shareholders are also less likely to chase after large mergers. These types of acquisitions typically end up more favorable for the acquiree instead of the acquirer. There is a real possibility that high-dividend mutual funds with low fees can outperform other funds while also generating more income!

Per usual, thanks for taking the time to read BrunchBucks. If you find a typo just contact me via email! Feel free to leave a comment below or share this with friends.