If I had to sum up the basic message of this blog, I could probably do it in three words – value, income, and diversification.
This is a blog for the income seeking investor who’s willing to be patient so long as the investments make a healthy cash return every year. Getting to a state of financial independence requires a valuable stock that generates income. However, a single company or stock will never be risk-free. There’s simply too much at stake and sudden downturn in a particular sector or a slight miscalculation shouldn’t bring down your entire dividend portfolio.
So, beyond the dividend and the value of the stock, there’s another element that is needed to keep your wealth chugging along – diversification.
Spreading your eggs in different baskets is the best way to make sure you never go broke or suffer a sudden jolt to your income. We recommend creating a stock portfolio with at least ten stocks that are in different sectors. On the other hand, you could simplify this process and buy a dividend mutual fund.
Mutual funds are really just baskets of investments. They are managed by professional managers and often promise a certain style or investment theme. Picking and investing in a mutual fund is often as easy as picking stocks. If you’ve considered mutual funds for your income portfolio, here’s what you need to know:
How Mutual Funds Work
Earlier this year we took a closer look at a certain type of mutual funds – closed ended funds. But it’s worth looking into what mutual funds are and how investors can benefit from them.
As the name suggests, mutual funds are investment products that pool money mutually. A crowd of investors pour money into a fund and the manager puts the money into stocks or bonds based on a pre-determined strategy. These funds can be traded on the market or only open to investors during a certain offer period.
Mutual funds always come with a prospectus, which details the finer points of the fund. It’s a document that outlines who runs the fund, who manages the money, how decisions are made, how much is deducted in fees, and how much is held in cash. Certain mutual funds might also outline their investment strategy. They could say they are aggressive, or rely on arbitrage, or are focused on reducing taxes, or simply want to reduce the risk of a market downturn.
Regardless of what you need, there’s probably a mutual fund out there to suit your needs. From 1997, the number of mutual funds in America have expanded. Now there are over 9,511 active mutual funds in the country. Hundreds of thousands of people rely on these funds. The largest asset manager, Blackrock, manages $5.4 Trillion. That’s a tremendously deep pool of assets for money managers to work on.
Mutual funds are a rich and diverse industry. You can pick fund that help investors play themes such as Latin American revival to artificial intelligence. For this piece and this blog, we’re focused on a specific sort of mutual fund. The sort that generates and offers lucrative dividends.
Dividend Mutual Funds
Dividend mutual funds have a clear mandate – create income for investors. These funds handle money in a way that the portfolio generates the highest possible dividend yield at the lowest possible amount of risk.
Mutual funds that pay monthly dividends, for example, create a fund and structure the cash flows so that the investors can enjoy monthly income from their investments. These mutual funds that pay monthly dividends could invest solely in dividend stocks with a monthly schedule. Or they could invest in stocks with high yields and organize the cash flows in a way that investors get their pay monthly.
Besides mutual funds that pay monthly dividends, there are other forms of dividend-oriented mutual funds. Some funds focus on reducing taxes by holding stocks for longer to qualify them. Others focus on getting the highest possible yield and paying out only once or twice a year. Quarterly dividends from mutual funds are also not uncommon.
Strategies such as borrowing money to invest in stocks (leverage), or accumulating dividends to pay out later are also common. The most common dividend structure for the mutual fund industry is semi-annual dividend payments and dividend reinvestments.
For the average investor who’s looking for capital appreciation, dividend reinvestment may be a clever option. This option lets the fund manager hang onto the dividend cash and give you more units of the mutual fund instead. In effect, you buy more of the fund with the dividend money. This augments the way your wealth expands over time. Instead of simply taking the dividends and spending them, you can buy more units, avoid taxes on the cash, and see your wealth grow.
However, this may not be the best option for investors who rely on dividend income for their monthly expenses.
Measuring fund performance is often easy. Mutual funds that pay monthly dividends also offer quarterly reports and regular updates to the fund’s net asset value or NAV. This shows how the fund is performing and how the individual stocks within the fund are appreciating.
Mutual funds also indicate a shift in the way investments are made or the relative allocation. If the mutual fund manager decides to put less money in stocks and more in bonds for the coming year, he or she will have to detail this in an update to investors.
The company or bank that runs the fund must also inform investors if the manager has changed. Manager’s have standardized track records that show how well their investments have performed. Over any given period, a fund must appreciate more than the index. Outperforming the index is a crucial measure that indicates the fund is creating and sustaining value. The U.S. Securities and Exchange Commission also has a bunch of other rules that dictate how mutual funds can advertise, sell their services, or report on their performance.
The Best Mutual Funds
Here are some of the best mutual funds that pay monthly dividends or offer attractive growth plans:
1. Vanguard High Dividend Yield Index Fund (VHDYX):
This mutual fund is designed as more of an index tracker. This means it can promise a high yield and still keep the expense ratio low. Right now the fund offers a 2.85% dividend yield while the expense ratio is only 0.15%. Not bad for a stable and steady income-oriented fund.
2. Vanguard Dividend Appreciation Index Fund (VDAIX):
VDAIX is another index tracker type of mutual fund. However, it tracks the NASDAQ US Dividend Achievers Select Index so you know it’s a high achiever. The fund has a great historical performance and currently offers 1.98% in yield for 0.17% in expenses.
3. Columbia Dividend Opportunity Fund (INUTX):
INUTX is a little more complicated. The mutual fund will combine the benefits of derivatives, preferred stock, dividend stocks and foreign stocks to create a mutual fund that pays dividends every quarter. The strategy pays off as the dividend yield is 3.8% but the expenses are higher too and the ratio works out to 1% or more.
4. Vanguard Dividend Growth Fund (VDIGX):
Vanguards growth fund is a star performer and has been paying consistent dividends since inception. The strategy varies between mid cap and large cap stocks here in the US, but there is one constant – dividends. Quarterly dividends based on stocks with high earning potential and outsized dividend payout ratios is the secret to success for this fund. VDIGX currently offers a 2% dividend yield at a 0.30% expense ratio.
5. T. Rowe Price Dividend Growth Fund (PRDGX):
Managers of PRDGX tracks mid cap stocks that has shown a trend towards higher earnings and expanding dividends. Based on historical data, the fund tracks down stocks that are likely to outperform both in terms of capital appreciation and dividend yield. The stock portfolio here is more global, which may be a good or bad thing depending on your perspective. However, the fund offers a very average 1.4% yield for a 0.64% expense ratio.
It’s rare funding stocks that pay a monthly dividend or diversifying your portfolio appropriately. Most average investors prefer mutual funds since investing and diversification is easier when the portfolio is professionally managed and easily accessible. There’s no doubt you can find a great mutual fund that pays a monthly dividend. Just a few good mutual funds should be enough to create a healthy and sustainable dividend portfolio for the long term.