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 into a single investment vehicle. Depending on the fund's mandate, they invest the 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 the funds income to pay dividends to their investors. They have the option to use the 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 pay.
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 must be distributed to investors on a proportional basis at least once each year.
However, some mutual funds specifically focus on owning stocks that pay dividends, especially those with a high dividend yield. Funds 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. 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 a broad equity market index and with dividend growth potential. This actively managed mutual fund benchmarks its performance against the S&P 500 and the Dow Jones U.S. Select Dividend Index.
As of the end of March 2022, the fund had $8.7 billion of assets and held 46 stocks. The top 10 fund holdings were:
- AbbVie (ABBV -4.32%): 5% of the portfolio
- British American Tobacco (BTI -2.23%): 4.2%
- Philip Morris International (PM -2.5%): 4.2%
- Enbridge (ENB -1.91%): 3.9%
- ExxonMobil (XOM -1.91%): 3.8%
- Gilead Sciences (GILD -2.4%): 3.7%
- Southern Company (SO -0.94%): 3.6%
- BCE (BCE -1.29%): 3.4%
- Chevron (CVX -6.72%): 3.4%
- Merck & Co. (MRK -2.59%): 3.4%
The fund focuses on sectors known for paying attractive dividends. The top five included healthcare (20.2% of the fund's holdings), utilities (16.7%), energy (16.3%), consumer staples (12.5%), and financials (9.4%). It also owns U.S. (72.5% of the fund's holdings) and international stocks (27.5%).
The mutual fund had a 30-day SEC yield of 3.5%, reflecting the dividends and interest earned after deducting the fund's expenses. That was considerably above the S&P 500's 1.6% dividend yield and the 10-year U.S. Treasury note, at 2.9%.
This dividend mutual fund generally has a minimum investment of $1,500. The relatively low minimum investment makes it easy for investors to start collecting passive income because it distributes dividends monthly.
The one mark against the fund is its expense ratio. With a gross expense ratio of 1.18%, it's almost double the mutual fund industry's average of 0.6%. The higher cost is the price investors pay for an actively managed fund that aims to deliver higher returns than a market index.
2. Vanguard High Dividend Yield Index Fund Admiral Shares (NASDAQMUTFUND:VHYA.X)
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. The 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 April 2022, the fund had $55.8 billion of assets and held 443 stocks. The top 10 fund holdings were:
- Johnson & Johnson (JNJ -2.28%) 3.3% of the portfolio
- Procter & Gamble (PG -1.76%): 2.7%
- ExxonMobil: 2.5%
- JPMorgan Chase (JPM -3.6%): 2.5%
- Home Depot (HD -0.55%): 2.2%
- Chevron: 2.1%
- Pfizer (PFE -3.37%): 1.9%
- AbbVie: 1.8%
- Bank of America (BAC -3.64%): 1.8%
- Coca-Cola (KO -0.97%): 1.8%
The fund had a 30-day SEC yield of 2.8% and distributed dividends quarterly. Like the FTSE High Dividend Yield Index, the fund weights heavily toward industries known for paying attractive dividends. It's top five sectors were financials (19.6% of the fund's holdings), healthcare (14.4%), consumer staples (13.4%), industrials (10.1%), and energy (9.1%).
The mutual fund has 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 worth pointing out that Vanguard offers a similar exchange-traded fund (ETF), Vanguard High Dividend ETF (VYM -1.53%), with a slightly lower expense ratio (0.06%) and a low minimum investment of one share ($105.81 as of May 23, 2022).
3. Vanguard Equity Income Fund Investor Shares (VEIPX -1.5%)
The Vanguard Equity Income Fund aims to provide investors with above-average current income. It invests in U.S. 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 April 2022, the fund had $52.3 billion of assets and held 195 stocks. The top 10 fund holdings were:
- Johnson & Johnson: 3.5% of the portfolio
- JPMorgan Chase: 3.1%
- Procter & Gamble: 2.8%
- Pfizer: 2.7%
- Cisco Systems (CSCO 0.37%): 2.2%
- Eli Lilly (LLY -1.39%): 2%
- Morgan Stanley (MS -2.32%): 2%
- Bank of America: 1.9%
- Chubb (CB -2.13%): 1.9%
- ConocoPhillips (COP -0.43%): 1.9%
The fund had a 30-day SEC yield of 2.3% and distributed dividends quarterly. The dividend mutual fund also focuses on sectors known for paying attractive dividends. Its top five were financials (18.7% of the fund's holdings), healthcare (17.6%), consumer staples (14.1%), industrials (10.2%), and information technology (9.8%).
The mutual fund has an expense ratio of 0.28% (about half the industry average) and a minimum investment of $3,000. Vanguard also offers a lower-cost version of the fund (Admiral Shares), with a 0.19% expense ratio. However, it has a much higher minimum investment of $50,000.
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Top-notch dividend mutual funds
Investors seeking to earn some passive income can use dividend mutual funds to achieve that goal. The strategy allows investors to own a diversified portfolio of higher-yielding, dividend-paying stocks, which should help lower their risk. Although 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 people seeking an attractive income stream.
Bank of America is an advertising partner of The Ascent, a Motley Fool company. JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Matthew DiLallo has positions in ConocoPhillips, Enbridge, Gilead Sciences, Home Depot, and Johnson & Johnson. The Motley Fool has positions in and recommends Cisco Systems, Eli Lilly and Company, Enbridge, Gilead Sciences, Home Depot, and Vanguard High Dividend Yield ETF. The Motley Fool recommends British American Tobacco, Johnson & Johnson, and Philip Morris International and recommends the following options: long January 2024 $40 calls on British American Tobacco, long January 2024 $47.50 calls on Coca-Cola, and short January 2024 $40 puts on British American Tobacco. The Motley Fool has a disclosure policy.
