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. Here are a few notable characteristics of the way dividend mutual funds work:
- Investment mandate: Mutual funds invest the pooled capital they receive into stocks, bonds, or other assets based on their stated mandate. For example, as the name implies, a dividend mutual fund invests in a diversified portfolio of dividend-paying stocks. That gives the fund income to pay dividends to its investors, who have the option to use the cash as they see fit, including reinvesting their dividends to buy more shares of the mutual fund.
- Fund types: 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.
- Expense ratio: Whether active or passive, mutual funds charge their investors a management fee known as the expense ratio. 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 five dividend mutual funds
Most mutual funds hold at least some stocks that pay a dividend, so 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 or targeting companies known for delivering dividend growth.
Five standout dividend yield-focused mutual funds are:
1. Federated Hermes Strategic Value Dividend Fund
NASDAQMUTFUND: SVAAX
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2. Vanguard High Dividend Yield Index Fund Admiral Shares
NASDAQMUTFUND: VHYAX
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NASDAQMUTFUND: VEIPX
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4. T. Rowe Price Dividend Growth
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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 Hermes Strategic Value Dividend Fund, Vanguard High Dividend Yield Index Fund, Vanguard Equity Income Fund, BlackRock Equity Dividend Fund, and T. Rowe Price Dividend Growth Fund stand out as the top options for people seeking an attractive income stream.
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