The slide in interest rates to record lows has prompted investors to flock to dividend stocks in search of reasonable yields. While the yield on a 10-year Treasury bond has plummeted to 1.4%, below the average yield on the broad Russell 2000 and large-cap S&P 500 indices, the yield on many dividend stocks has provided meaningful returns for prudent investors. Dividend stocks are at the epicenter of income investing in the current market.
In addition to individual stocks paying dividends, investors have plowed money into dividend mutual funds that have an added value of diversification across industries, which reduces risk and volatility of investment. Indeed, dividend mutual funds have been in high demand this year. According to EPFR Global, last year, investors withdrew $178.2 billion from equity products, while they invested $26.8 billion into dividend-focused funds. This year so far, “investors have plowed a net $16 billion into U.S. dividend equity funds, with inflows picking up in recent weeks. By contrast, they withdrew net $25 billion from non-dividend funds,” according to Wall Street Journal's citing of EPFR data.
Inflows into dividend mutual funds are for a good reason. Investors are realizing that, in principle, during the volatile markets, and mainly in the bear markets, investments in dividend-paying stock outperform the broad market and especially those stocks that do not pay any dividends (see example graph below). In general, dividends have been a critical component of total stock market return, averaging some 44% of total returns. In the weak and volatile markets, dividend returns comprise a significant share of total return on investment.
Investors seeking attractive yield among dividend mutual funds have several investment options. They can choose between yield and growth. High-yield dividend mutual funds seek current income, while dividend growth funds attempt to capture dividend growth that increases income streams in the future. Many dividend growth funds seek equities that produce dividend growth in excess of the current rate of inflation.
Of course, investors should evaluate each fund's fundamentals, instead of focusing on the yield alone. Investors should thus consider funds' total return potential. The fund's holdings and industry or geographical allocations will determine the quality of dividend mutual funds. While the strong demand in recent years has boosted price-earnings ratios of dividend mutual funds, investors should make sure they do not overpay for their investment. Moreover, annual expense ratios, which can eat up a significant share of the yield, are also a relevant factor to consider.
The table below summarizes a selection of high-quality, no-load and low-fee dividend mutual funds for investors seeking above-average yields on equity investment.