Why is dividend investing a popular strategy? When you invest in the stock of a company that pays dividends, you get paid simply for holding onto the stock. If the stock has appreciated by the time you're ready to sell it, you get to cash in on that, too.
Companies that pay dividends tend to be large and established and their stock is generally less volatile than stocks that don't pay dividends. And even though dividends are taxable, you pay at the favorable capital gains rate (15 percent).
Investing in a dividend fund has the same benefit as owning stocks that pay dividends-you create an income stream. You'll receive a check from the fund on a quarterly or annual basis. (Check with the fund for frequency and type of payment option.) Or, you can choose to grow your investment in the fund through dividend reinvestment. Financial planner Brian H. Hensen of North Star Resource Group, in Madison, WI, sums up the advantage: "Holding an equity income fund in your portfolio can provide some predictable yield to help offset the overall volatility of the market."
Options American Century Investments' Equity Income Fund. A typical dividend fund may limit its investments to sectors known for their high yields, like utilities or financials. But that's not the case with this fund. Managers Phil Davidson and Scott A. Moore cast a much wider net in their quest for low-cost stocks with high yields. They've limited the fund's downside risk by keeping a portion of the fund in preferred stocks and convertible bonds to generate income.
Says financial planner Brian Hensen, "I like the fund's performance in volatile markets. It posted losses in only two of the past 10 years and the worst was a moderate 5 percent decline in 2002." This performance is reflected in the fund's rank in the top three percent of its large value category for five- and 10-year returns.
TCW Galileo Dividend Focused Fund. This fund typically keeps at least 80 percent of its assets in equity securities of companies with records of paying dividends. Manager Diane E. Jaffee's goal is to provide a higher-than-average yield, while reducing volatility through diversification. She does this by investing in stocks from the largest sectors of the S&P 500, as well as in historic high-yield areas like utilities. And like the American Century fund, she's not limited to companies of a specific size.
What does she look for? In addition to high dividends, Jaffee's management team also looks for businesses that trade at low valuations and have opportunities for appreciation. For example, she bought Nokia in 2004 based on its low price/book ratio and price/cash-flow ratio, as well as its increased szpending on research and development. Nokia is up 10.8 percent so far this year.
Jaffee has been the lead portfolio manager for four years, but has been on the fund's management team since 1995. "I like the consistency in management," says Hensen.
Each month, we feature two mutual funds in a single investment category. We select them based on performance, market trends, and interviews.