High-dividend mutual funds are popular during periods when interest rates are low, as they satisfy the income needs of many investors. Stock dividends are measured by their yield, which is the annual dividend amount divided by the current stock price. High-dividend mutual funds select stocks with yields over a self-imposed threshold. Because high-dividend yields make stocks attractive, these stocks tend to have greater price stability than those that pay little or no dividends.
A mutual fund is run by a fund management company, which is responsible for picking investment managers and operating the funds. This includes marketing the funds to new customers, handling purchase and redemption requests, and disclosing important details about the fund and its performance. Investor money is pooled and used to purchase shares that fit into the fund’s strategy. Mutual funds typically charge from 0.5 percent to 2.0 percent annually for the assets under management.
A good high-dividend fund will provide annual income in excess of the dividend yield produced by some benchmark index, such as the S&P 500. For example, an investment manager may decide that when the S&P 500 dividend yield is 2 .0 percent, her fund must yield at least 2.5 percent. There are many mutual funds with yields above 4.0 percent that have a high rating from sources such as Morningstar.
Besides seeking out high dividends, mutual funds evaluate the quality and consistency of high-dividend stocks. They want to know how long dividends have been paid without interruption. They favor stocks of corporations that have a consistent record of raising dividends by 8 percent to 10 percent a year. One question mutual funds ask is whether a company had to take extraordinary actions to preserve its dividend, such as rampant cost-cutting. Well-rated high dividend funds pick stocks that will continue to deliver increasing dividends.
Comparison With Stock Ownership
Mutual funds usually have a lot of money, so they must buy big blocks of stock in order to impact performance. This creates a problem regarding liquidity -- the ability to easily trade a stock. Many smaller companies offer high dividends but have not issued a lot of stock. Big mutual funds, even if they could find these shares, couldn’t buy enough of them to make a difference to the fund’s return. Individual investors can benefit from owning these stocks in a way that mutual funds cannot. Nonetheless, it is much easier to achieve risk-reducing diversification via a mutual fund than through assembling your own portfolio of stocks.
- Dividend Investing - The Truth About Dividends and Long Term Income Investing; Derrick Murray, Sonny Collova
- Income for Life Dividend Secrets; James Tower, David Newcastle
- Dividend Stocks For Dummies; Lawrence Carrel
Based in Greenville SC, Eric Bank has been writing business-related articles since 1985. He holds an M.B.A. from New York University and an M.S. in finance from DePaul University. You can see samples of his work at ericbank.com.