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How Do Dividend Mutual Funds Work?

March 16, 2022
4
min

Mutual funds allow investors to secure diversification within their portfolios. Here's our complete guide to understanding the different types of dividend mutual funds.

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Companies share profits with shareholders via regular payments called dividends. Dividend mutual funds invest in stocks and pay regular dividends to their investors. These are per-share payments, which means the more shares an investor owns, the higher their dividends. The investor owns dividend stocks of companies through the mutual fund; they then receive the dividend through the mutual funds, typically quarterly. The investor can either reinvest the dividends or opt for cash dividends. 

Dividend mutual funds usually aim to invest in shares of companies known for high and consistent returns. When investing in a fund, investors can either make a reinvestment plan with their dividends to buy more shares rather than receive the dividend income immediately.

How do mutual funds pay dividends?

Mutual funds can be thought of as a collection of securities or a pool of investments that pay shareholders dividends. Different mutual funds have different payment timelines. For example, some pay quarterly, while others pay monthly dividends. 

Investors receive dividend payments after expenses, meaning the investor typically should expect a low personal cost when investing in a dividend mutual fund. Dividend mutual funds allow investors to assume less risk when investing in a dividend stock. By pooling many stocks that pay dividends, the individual investors will likely not notice significant changes if one stock no longer pays dividends.

What are the different types of dividend mutual funds?

Dividend mutual funds focus on different objectives. Some dividend mutual funds focus on ensuring a high yield, while others focus on growth by increasing the number of their dividends. Funds also vary in the minimum investment required and the rate of the fund expenses.

Dividend ETFs

Dividend exchange-traded funds—or ETFs—are another alternative to dividend mutual funds. Essentially, these are a diversified collection of dividend-paying stocks that aim to resemble the market index as closely as possible. The difference between a dividend ETF and a mutual fund is that ETFs are traded like stocks, and their value can fluctuate throughout the day, while a mutual fund's value changes only once daily. ETFs typically have an expense ratio that's taken out of the investor's dividends. As with mutual funds, different ETFs will have different yields and expenses. Typically, ideal dividend ETFs have high yields and low expenses.

What are the highest dividend ETFs and mutual funds?

Investors consider several factors when choosing a dividend ETF or mutual fund. The first is the dividend yield, determined by how much a company pays relative to the share price. The dividend yield is presented as a percentage and allows investors to measure a fund's performance. A high yield ETF allows an investor to grow their capital quickly.

When investing in an ETF, investors should also ensure the fund is in stocks rather than bonds. The size of the stock, determined by how much a company pays relative to the share price, also comes into play; large-cap funds tend to be the least risky.

Dividend ETFs list:

  • Schwab US Dividend Equity ETF (SCHD). This ETF outperformed the S&P 500 in returns in the first half of 2021. It’s composed of companies with a reputation for consistently paying dividends.
  • Invesco S&P Ultra Dividend Revenue ETF (RDIV). Based on the S&P 900 Dividend Revenue-Weighted Index, this fund consists of 60 stocks selected from the S&P 500 and the S&P Midcap 400 Indexes.
  • SPDR Portfolio S&P 500 High Dividend ETF (SPYD). As the name suggests, this ETF consists of 80 top S&P 500 dividend stocks.
  • Vanguard High Dividend Yield ETF (VYM). This diversified ETF holds 412 stocks, ensuring investors will notice only minor fluctuations if a company stops paying dividends.
  • Vanguard Real Estate ETF. This fund invests exclusively in real estate investment trusts or “REITs.” It invests in various high-yield REITs.

Dividend mutual funds list:

  • The Vanguard High Dividend Yield Index Admiral Shares (VHYAX). Made up of companies that have a record of consistently producing high-yield dividends for investors, this mutual fund has a very low cost ratio of just .08%.
  • Fidelity Dividend Growth Fund. A large-cap growth fund consisting of diversified domestic assets that has been actively managed for 25 years.
  • The Columbia Dividend Opportunity Fund (INUTX). Since its inception in 1988, this fund aims to include companies with a consistent history of paying dividends. It requires a minimum $2,000 investment, with an expense ratio of 1.05%.
  • The Federated Strategic Value Dividend Fund (SVAAX). Consisting of companies with high monthly dividends for investors and an emphasis in growth stocks, this fund has a relatively low minimum investment of $1,500 with a 1.06% expense ratio.
  • The Neuberger Berman Equity Income Fund (NBHAX). Founded in 2005, this fund’s diverse investments include REITs, bonds, stocks, put options, and call options. Currently, its minimum initial investment is $1,000.
  • The T. Rowe Price Dividend Growth Fund (PRDGX). Since its inception in 1993, this fund aims to invest in companies with a strong past performance and increase dividends over time for high returns. It has a low expense ratio of .63%.

The bottom line

Mutual funds and ETFs allow investors to secure diversification within their portfolios. Diversified funds also help investors withstand volatility in the market. For example, if one company in a fund stops paying dividends, the investor will likely only notice a minimal change in their dividend income. As an investment, mutual funds that offer dividends can give investors significant capital gain with low risk and costs. A dividend investment strategy can help investors grow their portfolios or provide steady dividend income for years.

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