Dividend stocks often make excellent investments. Companies that pay dividends have historically outperformed the S&P 500 with significantly less volatility. That’s because the dividend income is a meaningful contributor to a stock’s total return (share price appreciation plus dividends).
However, with so many companies making dividend payments, it can be challenging to pick the best dividend stocks. That’s where dividend mutual funds can help. They allow investors to own a diversified portfolio of stocks that generate dividend income.
Here’s a closer look at how dividend mutual funds work and some of the top dividend mutual funds to consider.
How dividend mutual funds work
A mutual fund pools investor capital together into a single investment vehicle. Depending on the fund’s mandate, they invest that money into stocks, bonds, or other assets. As the name implies, a dividend mutual fund invests in a diversified portfolio of dividend-paying stocks. That gives these funds the income to pay dividends to their investors, who have the option to use this cash as they see fit, including reinvesting their dividends to buy more shares of the mutual fund.
There are two types of dividend mutual funds: passively or actively managed. Passively managed dividend mutual funds are index funds that aim to track a particular dividend-related index. Meanwhile, actively managed dividend mutual funds buy and sell the top dividend stocks, striving to outperform a specific index.
Passively managed mutual funds usually have a lower expense ratio than actively managed funds. As a result, these mutual funds pay a higher percentage of the dividend income they receive to their investors than actively managed funds do.
With these factors in mind, here’s a closer look at some of the top dividend mutual funds.
Top dividend mutual funds
Most mutual funds hold at least some stocks that pay a dividend. Because of that, they collect some dividend income that they must distribute to investors on a proportional basis at least once each year.
However, some mutual funds focus specifically on owning stocks that pay dividends, especially those with a high dividend yield. Those geared toward this strategy usually make more frequent distributions, typically quarterly or, in some cases, monthly. We’ll focus our dividend mutual fund search on those offering above-average yields.
Three standout dividend yield-focused mutual funds are:
1. The Federated Strategic Value Dividend Fund (NASDAQMUTFUND: SVAAX)
The Federated Strategic Value Dividend Fund aims to generate income and long-term capital appreciation. It invests in stocks with higher dividend yields than the broad equity market index and dividend growth potential. This actively managed mutual fund benchmarks its performance against the Dow Jones U.S. Select Dividend Index.
As of the end of August 2021, the fund had $7.6 billion of assets and held 45 stocks. The top 10 fund holdings were:
- AbbVie (NYSE:ABBV): 4.9% of the portfolio
- Philip Morris International (NYSE:PM): 4.8%
- Chevron (NYSE:CVX): 4.2%
- ExxonMobil (NYSE:XOM): 4.1%
- Enbridge (NYSE:ENB): 3.8%
- BCE (NYSE:BCE): 3.8%
- Southern Company (NYSE:SO): 3.8%
- British American Tobacco (NYSE:BTI): 3.7%
- Gilead Sciences (NASDAQ:GILD): 3.7%
- Merck & Co. (NYSE:MRK): 3.1%
The fund had a gross weighted average dividend yield of 4.5% and a 30-day SEC yield of 2.9%, reflecting the dividends and interest earned after deducting the fund’s expenses. That was considerably above the S&P 500‘s 1.3% dividend yield and the 10-year U.S. Treasury Note, at 1.3%.
Further, the gross yield is above the 3.8% yield of its benchmark. The fund makes it easy for investors to collect passive income because it distributes dividends monthly.
The one mark against the fund is its expense ratio. With a gross expense ratio of 1.19%, it’s almost double the mutual fund industry’s average of 0.6%. This fund generally has a minimum investment of $1,500.
2. Vanguard High Dividend Yield Index Fund Admiral Shares (NASDAQMUTFUND: VHYAX)
The Vanguard High Dividend Yield Index Fund provides broad exposure to U.S. companies that have consistently paid above-average dividends. It emphasizes slower-growing, higher-yielding companies.
This passively managed mutual fund benchmarks its returns against the FTSE High Dividend Yield Index. That index tracks stocks of U.S. companies that have paid above-average dividends for the past 12 months, excluding real estate investment trusts (REITs).
As of the end of August 2021, the fund had $50.1 billion of assets and held 412 stocks. The top 10 fund holdings were:
- JP Morgan Chase (NYSE:JPM): 3.5% of the portfolio
- Johnson & Johnson (NYSE:JNJ) 3.4%
- Home Depot (NYSE:HD): 2.6%
- Procter & Gamble (NYSE:PG): 2.6%
- Bank of America (NYSE:BAC): 2.3%
- Comcast (NASDAQ:CMCSA): 2%
- Pfizer (NYSE:PFE): 1.9%
- Cisco Systems (NASDAQ:CSCO): 1.8%
- ExxonMobil: 1.7%
- Verizon Communications (NYSE:VZ): 1.7%
The fund had a 30-day SEC yield of 2.7% and distributed dividends quarterly.
This mutual fund had an expense ratio of 0.08%, well below the mutual fund industry’s average expense ratio. The fund also has a minimum investment of $3,000. It’s also worth pointing out that Vanguard offers a similar exchange-traded fund (ETF), Vanguard High Dividend ETF (NYSEMKT:VYM), with a slightly lower expense ratio (0.06%) and a low minimum investment of one share ($102.52 as of Sept. 21, 2021).
3. Vanguard Equity Income Fund Investor Shares (NASDAQMUTFUND: VEIPX)
The Vanguard Equity Income Fund aims to provide investors with above-average current income. It invests in companies dedicated to consistently paying high dividends. The actively managed mutual fund benchmarks its returns against the FTSE High Dividend Yield Index.
As of the end of August 2021, the fund had $50.5 billion of assets and held 192 stocks. The top 10 fund holdings at the end of the second quarter of 2021 were:
- JPMorgan Chase: 3.8% of the portfolio
- Johnson & Johnson: 3.7%
- Bank of America: 2.9%
- Cisco Systems: 2.6%
- Procter & Gamble: 2.6%
- Comcast: 2.2%
- Eli Lilly (NYSE:LLY): 2.1%
- Morgan Stanley (NYSE:MS): 1.9%
- Home Depot: 1.9%
- Phillip Morris International: 1.8%
The fund had a 30-day SEC yield of 2.2% and distributed dividends quarterly.
This mutual fund had an expense ratio of 0.28% (about half the industry average) and a minimum investment of $3,000. It’s worth noting that Vanguard offers a lower-cost version of this fund (Admiral Shares), with a 0.19% expense ratio. However, it has a much higher minimum investment of $50,000.
Top-notch dividend mutual funds
Investors seeking to earn some passive income can use dividend mutual funds to achieve that goal. This strategy allows investors to own a diversified portfolio of higher-yielding, dividend-paying stocks, which should help lower their risk. While there are many dividend mutual funds out there, the Federated Strategic Value Dividend Fund, Vanguard High Dividend Yield Index Fund, and Vanguard Equity Income Fund stand out as the top options for those seeking an attractive income stream.