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These Funds Are Tops for Dividends

A few of our favorites that prefer a bird in the hand.

Marta Norton, 07/24/2007

Dividend-centric investment strategies are back.

True, investing for dividends is by no means a new approach, but it fell out of favor during the 1980s and 1990s, when companies and investors alike favored growth strategies over returning income to shareholders. A number of factors, including the market, a tax cut, and demographics, have helped dividends regain their popularity. The long value rally of recent years has helped bring attention to stable, income-producing companies. In 2003, the government made dividends friendlier to the tax-averse by slashing the dividend tax rate to 15%. (Unless extended, this tax relief will expire in 2010.) Finally, aging baby boomers have gotten more interested in current income as they approach retirement.

The general premise behind dividend-centric strategies has merit. Over the long haul, reinvested dividends have provided a big part of total return. An Ibbotson study shows that reinvested dividends accounted for 40% of total stock returns from 1926 to 2006. Dividends also impose financial discipline on companies. Dividend-paying companies tend to budget more carefully and avoid wasteful projects because investors will punish their stock if they don't reliably return profits to shareholders.

Dividend funds have enjoyed tailwinds during the value-driven bull market, and that won't last forever. Moreover, the fund industry has launched a lot of gimmicky dividend-focused offerings that you should avoid. (Does anyone really need Claymore/Zachs Yield Hog ETF CVY?) Still, given their long-term appeal, we thought we'd highlight a few of our favorites.

T. Rowe Price Equity Income PRFDX
This fund is an Analyst Pick in the large-value category. Longtime manager Brian Rogers targets beaten-down behemoths with healthy yields. Not all of Rogers' picks turn around quickly, so the fund can languish when its picks founder. Moreover, the fund typically lags its peers in growth-friendly markets. On the flip side, the value-conscious, dividend-focused approach gives the fund a cushion against falling stock prices in market downturns. Plus, over the long haul, Rogers has produced strong returns. The fund's 9.5% gain for 10 years ending July 17 outpaced 77% of its peers.

T. Rowe Price Dividend Growth PRDGX
This T. Rowe fund takes a slightly different tack. Manager Tom Huber looks for reasonable valuations and increasing dividends. Thus, he can invest more in the technology stocks, such as Intel INTC and Cisco CSCO, that pay small, but growing dividends. The fund's dividend focus has helped it better survive market downturns than its large-blend peers. In 2002, for example, the fund's 18% loss, while painful, was better than 73% of its rivals. With strong long-term returns as well, this offering is a sensible core holding.PAGEBREAK

Allianz NFJ Large Value PNBAX
NFJ Investment Group is a small firm focused exclusively on dividend investing. Its management team screens for dividend-paying stocks and reasonable valuations for each of the firm's six offerings. This disciplined approach can lag in speculative rallies (the firm's mutual funds did poorly in 1999, for example), but, with the help of reasonable expenses, it's paid off over the long haul. A number of its funds are closed to new investors, including Allianz NFJ Small Cap Value PCVAX and Allianz NFJ Dividend Value PNEAX, but in the past few years, the firm has introduced Allianz NFJ International Value AFJAX, Allianz NFJ Large Cap Value PNBAX, and Allianz NFJ Mid Cap Value ANVAX, all of which are still open. Allianz NFJ Large Cap Value seems particularly well positioned, because it's focused on the long out-of-favor mega-caps.

Vanguard Dividend Appreciation ETF VIG
This exchange-traded fund (and conventional share class) is timely. Its benchmark, Dividend Achievers Select Index, is a market-cap-weighted index of companies that have increased their dividends in each of the last 10 years, so the fund is tilted toward the undervalued, financially solid behemoths. Some income-oriented investors might be put off by the fund's yield, which pales in comparison with those of some of its dividend-focused competitors, such as PowerShares HighYield Dividend Achievers' PEY, which offers a 3.46% yield. However, this fund has a few advantages over its competitors. The index applies a quant screen devised by Vanguard to the broad Dividend Achievers Index to weed out companies whose dividends may be unsustainable. Plus, like all Vanguard offerings, the ETF's 0.27% expense ratio is low, which gives it an edge over most of its rivals. (Unless you trade too much, then the commission you pay to buy and sell ETFs will add up.)

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