Four Dividend-Focused Equity Funds to Add Income

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.

 T. Rowe Price Real Estate (TRREX)
Trailing 12-month Yield: 7.63%
SEC Yield: N/A
This fund resides in the real estate category along with most other funds that focus on real estate investment trust firms. Funds in this category can often be good income options because the REIT structure legally requires firms to pass along 90% of earnings to investors. One should note, however, that REIT dividends are not tax-advantaged and are therefore taxed as ordinary income. As a result, this fund is best held in a tax-sheltered account. Management here employs a variety of methods to identify some of the larger, and higher-quality, real estate stocks. With more than 10 years at the helm, management has not only delivered strong total returns but has also provided an average calendar-year yield of more than 4.5% over that time. That said, while this fund is still a favorite of ours, we'd urge some caution about loading into the real estate sector now, as continued stress in both the residential and commercial real estate markets could continue to pressure the sector, and dividend payout could continue to see cuts for some time to come.

 Eaton Vance Dividend Builder (EVTMX)
Trailing 12-month Yield: 4.70%
SEC Yield: 2.13%
This fund may also be of interest to the income-hungry. Formerly, this fund focused on utilities firms, but as of its Aug. 15, 2007, mandate change, management has turned its attention toward stocks with growing dividends from varying sectors. Only 15% of fund assets are still in the utilities sector, and we're optimistic that the fund can maneuver its expanded universe well. Management has good experience beyond the utilities sector, having comanaged a diversified income-focused closed-end fund. Moreover, the fund has a more global mandate than some (recently 31% of the fund's stocks were in foreign firms), and many of the best dividend-paying stocks are now found outside the United States. So, while the fund will now look less distinctive versus other equity-income options than it once did, we think that management's long experience in the mainstay utilities and telecom sectors, added to more general experience in dividend-focused investing, should serve investors well.

 Thornburg Investment Income Builder (TIBAX)
Trailing 12-month Yield: 7.53%
SEC Yield: 7.42%
This offering is also a fund where management understands the importance of looking abroad when searching for strong dividend-paying stocks (recently nearly a third of assets were in foreign stocks). The team has long argued that international firms have shown a greater willingness to pay dividends to shareholders than have their U.S. counterparts; in particular, European companies are increasingly improving dividend policies. Moreover, management seeks to invest in firms that cannot only sustain an appealing dividend payout, but also have the potential and willingness to increase it. Historically speaking, the fund has held a more modest position in bonds than many of its world-allocation category counterparts, which held the fund back as its equity-heavy portfolio swooned through the financial crisis. Still, we think that management's experience and its flexible and opportunistic approach should help make the fund a compelling offering for those seeking income.

At a time when yields in various sectors of the fixed-income marketplace are quite compelling and, conversely, cash and Treasury-market yields are meager, it's still very important to consider equity-oriented funds that can offer income, both as a bulwark against market gyrations and as a complement to bond funds in an income-producing portfolio.

An earlier version of this article originally appeared inMorningstar FundInvestor.