Delightful Dividends

Delightful Dividends

This past summer, Alan Greenspan set off a rise in interest rates that many experts believe is only the start of a steady increase. If you are invested in stocks and equity mutual funds, this could well signal a period of low or no returns since higher rates generally lure investors out of stocks.

Historically, however, there’s been a notable exception. Companies that pay a portion of their profits to shareholders in the form of dividends tend to see their share prices hold up better when rates climb. The reason is simple — their financials are typically strong enough to allow management to hand out a portion of the company’s cash reserves. Also, when stocks stall, investors often flock to dividend yields as a source of returns. In fact, dividend yield has made up about 40% of the S&P average annual total return of 10.5% since 1926. “You could argue that yield is an indicator of quality earnings since companies need to have steady profits to pay dividends,” says S&P Strategist Sam Stovall.

There are high-yielding equity mutual funds that take advantage of the track record of such companies. They collect company shares, often with an eye to maximize the dividend income their fund amasses over time. Morningstar Analyst and Certified Financial Planner Paul Herbert says many of these funds tend to be invested in large company shares because big corporations usually have the means to pay dividends. Many of the funds that pursue dividend yields will have the words ‘equity income’ in their name as well. Investors can check for high-yielding equity funds by comparing the fund’s yield to the 1.6% figure offered by the S&P 500 Index, a benchmark covering the overall market.

Recent changes that have lowered taxes on dividend yield distributions have prompted a number of mutual fund companies to create high-yielding mutual funds to market. If you hold a high-yielding equity fund in an IRA or tax sheltered account, you needn’t worry. You won’t be taxed on the dividend distributions your fund pays out to you. If you hold a high-yielding equity fund in a taxable brokerage account, you may have to pay taxes on that fund’s dividend distributions. Check your fund’s brochure for details.

With the help of mutual fund tracking firm Morningstar, we sifted through the universe of high-yielding funds in the hopes of unearthing a few good candidates. We subtracted sector funds, particularly utilities and those that focus on real estate investment trusts (REITs), since narrowly focused funds often undergo violent swings of fortune. We also focused on funds with at least a five-year track record in order to identify sound management. That way you can see how funds have weathered the 2000 to 2002 bear market, a good indicator of how they might fare in other downturns.

Our list was headed up by Dodge & Cox Stock (DODGX), a fund that was closed to new investors when this article was written. Its track record is strong, however, and you might want to check back in the