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Four Dividend-Focused Equity Funds to Add Income

Income-focused equity funds can be a powerful addition to investors' tool kits.

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Although it's generally the case that fixed-income funds offer much higher yields than can typically be had among equity mutual funds, it is still important to look beyond bonds when constructing an income-producing portfolio and asset allocation. And while many firms have been in dividend-cutting mode during the recession, that shouldn't frighten investors away from income-focused equity funds, as there are still some excellent options out there that can help supplement bond funds by providing strong income streams. As is well known, dividends have historically constituted an important part of a stock's total return over time, and as the economy eventually recovers, so, too, should many stocks' payouts. Moreover, with equity price levels still considerably below prior peak levels, average dividend yields are looking considerably more attractive today than they were roughly a year ago. In fact, the SEC yield (which looks to the 30-day period ended the last day of the previous month, unlike the trailing 12-month yield, which makes the calculation over the past year) on the S&P 500 Index has risen near half a percentage point, to 2.56%, over the past year. Many firms have slashed dividend payments, but prices have fallen even further, driving yields up.

Some may try to invest directly in dividend-paying stocks, but while that may be an option for a modest portion of an investors' portfolio, gaining stable dividend exposure through direct stock investment can be tricky for most investors and can expose them to significant volatility and stock-specific risk. Rather, we suggest looking to top fund options instead. And while some of the best options are already quite well known, such as  American Funds Capital Income Builder (CAIBX), we've highlighted four others below (in no particular order) that deserve more attention and can provide investors with a compelling income stream while also contributing to the total return potential of their portfolio.

 Vanguard Equity-Income (VEIPX)
Trailing 12-month Yield: 4.92%
SEC Yield: 3.58%
This offering sports rock-bottom expenses, which are a vital component to a good income-oriented fund because a fund's expense ratio works against its income-producing potential. Moreover, beyond the sustainable competitive advantage afforded by low cost, this fund benefits from the strong and value-conscious management practiced by esteemed subadvisor Wellington Management Company. Equity-Income has its assets divided between Wellington (managing 60% of assets) and Vanguard's Quantitative Equity Group (40%). The fund's low cost and solid management have come together to offer investors attractive yields historically. In fact, the trailing 12-month yield is well above broad market yield averages, and despite the lower SEC yield and the challenge of navigating this market, we think the payout should remain solid. Importantly, however, management here also looks well beyond mere yield, searching out companies that it believes cannot only sustain stable dividend payments, but also whose stock holds good risk/reward characteristics. This has allowed the fund to also deliver competitive total returns over time, and its tax-sensitive low-turnover style keeps capital gains taxes modest.

Lawrence Jones does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.