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Yield to Yield

Some dividend funds offer more, or less, than investors bargain for.

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Income-seeking investors have been in a tough spot lately. Bond, CD, and money market yields are paltry. Pitiful fixed-income yields might make stock dividend yields look attractive by comparison, but they come with extra company-specific and market risk. The 15% tax rate that most stock dividends have enjoyed for the past seven years could expire at the end of the 2010.

However, more companies seem well-situated to reinstate or increase their payouts after using the aftermath of the financial crisis to pay down debt, bolster balance sheets, and amass cash. Some high-quality companies, like  Johnson & Johnson (JNJ), even offer dividend yields higher than the yields on their 10-year corporate bonds. This rare phenomenon makes dividend-paying stocks more appealing to income-seeking investors. So does market volatility, because dividend-paying companies tend to be defensive.

About 60 distinct funds in Morningstar's database use the word "dividend" in their names (many others pursue an equity-income objective), but it's a diverse bunch. Some are dividend funds in name only, while others are dividend zealots that won't own a stock without a payout. Some chase the fattest yields, while others care more about a company's ability to grow its dividend over time. And of course there are a whole bunch of funds in between. The bottom line is that dividend funds don't ensure safety and security, and some introduce even more risk in pursuit of yield.

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Katie Rushkewicz Reichart has a position in the following securities mentioned above: VDIGX. Find out about Morningstar’s editorial policies.