Don't Let Low Yields Scare You From These Funds

Investors who own equity funds generally are looking for capital appreciation, income, or both. But in recent years, as low interest rates have led many income-oriented investors to shun bonds in favor of dividend-paying stocks, more attention than usual has been paid to a fund's yield.

Although yield can be of particular importance to some investors--especially retirees dependent on their investments to cover living expenses--it's easy to lose sight of the fact that even funds with low or nonexistent dividend yields can be good long-term investments. As Christine Benz, Morningstar's director of personal finance, pointed out in her article, "Stop Scrounging for Income and Sell Some Stocks," a total-return perspective--which incorporates both capital appreciation and income generated by an investment--often serves investors better than a narrow focus on income. In fact, a fund with a low yield will provide stronger total returns than one with a much higher yield if its holdings perform well enough.

A fixation on yield also might cause an investor to unwittingly tilt his portfolio toward dividend-paying sectors, such as consumer staples and utilities, and away from others, such as technology. Thus, a fund that happens to pay a lower yield might be needed to help with sector diversification. As an example, in the runup to the 2008 financial crisis, a yield-seeking investor might have loaded up his portfolio with dividend-paying financial-services stocks, leading to disastrous results when the sector tanked.

A low-yielding fund also can provide diversification in other ways--for example if it offers below-average volatility that can help stabilize the risk profile of a portfolio.

If you're the type of investor who reflexively avoids funds with below-average yields but are wondering whether you've been overlooking worthwhile funds as a result, our  Premium Fund Screener tool can offer some guidance. We set the tool to find medalist U.S.-equity funds with SEC yields lower than 1.5% (the S&P 500 currently yields around 2%) and below-category-average expense ratios--after all, you don't want high fees eating away at those all-important returns. We screened out institutional funds and those closed to new investors as well as funds that carry a sales charge, though investors who don't mind paying a load or who have access to load-free versions of some funds can simply remove that part of the screen. Premium Members can  click here to see the full screen, which includes the following funds.

 Vanguard Small Cap Index (NAESX)     
Yield: 1.19% | Analyst Rating: Gold     
This fund recently changed its benchmark to the CRSP US Small Cap Index and provides diversified exposure to U.S. small-company stocks. (Be aware that many smaller companies don't pay dividends so that they may reinvest in themselves, so it's not uncommon to find low yields among funds that invest in these smaller companies.) As with the majority of Vanguard index funds (and the many other Vanguard funds on the list) low costs are a major advantage here. The fund's 0.24% expense ratio is low for a small-cap, no-load fund ( Vanguard Small Cap ETF (VB), an exchange-traded version of the fund, is even cheaper at just 0.09%). Although it simply tracks the small-cap market, the fund has delivered top one-third annualized returns in the small-blend category during the trailing three-, five-, and 10-year periods.

 Amana Growth (AMAGX)     
Yield: 0.34% | Analyst Rating: Silver    
Designed for Muslim investors but open to anyone, this large-growth fund avoids stocks that get more than 5% of their revenues from alcohol, tobacco, gambling, pornography, or pork. Financials stocks are also excluded because of the Islamic prohibition on paying or receiving interest, which also leaves out companies with debt/market-cap ratios greater than 30%. The fund is heavily weighted toward technology (40% of the portfolio, or nearly double the category average, as of March 31), and health care (24% versus 16% for the category). The fund keeps volatility in check by investing in stable, growing companies but is prone to periods of underperformance when its style is out-of-favor. The fund has underperformed in recent years as financials have rallied, but its 10- and 15-year records remain in the top 5% of its category. Its 1.11% expense ratio is above-average for a large-cap, no-load fund but below the large-growth category average of 1.23%. Also bear in mind that fund fees generally are deducted from income, with whatever remains being passed on to shareholders, so the fact that funds like this have low yields may be partly attributable to their fee levels.