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Morningstar's Favorite High(er)-Yielding Equity Funds

These active and index funds/ETFs offer decent yields and don't take crazy risks.

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On the hunt for a dividend-paying mutual fund or ETF?

To help identify the right one for you, Morningstar's director of global ETF research Ben Johnson suggests separating the universe into two camps: growers and yielders.

Dividend-growth-focused funds (the "growers") don't have the lushest yields around; in most cases their dividend yields are below that of the S&P 500. Paying out at least some yield keeps such companies' managements disciplined and accountable; not overshooting on the yield front allows them to reinvest in their businesses.  Vanguard Dividend Growth (VDIGX), which recently announced its closure to new investors, has long been one of Morningstar's favorites among the "growers"; this article details some of Morningstar analysts' other favorites of that ilk.

"Yielders," meanwhile, prioritize dividend yield; they can be especially good choices for retirees who are seeking current income from their investments. Higher-yielding stocks frequently operate in more mature businesses where paying out profits rather than reinvesting them is the more prudent avenue for shareholders. Such high-yielding stocks have historically clustered in the financials, energy, utilities, and industrial sectors, to name a few. But many technology firms have begun paying out or have increased their dividends in recent years; these days, it's not unusual to see the likes of  Microsoft (MSFT) and Intel (INTC) in dividend-focused fund portfolios. 

As compelling as investing for yield is, investors on the hunt for high-yielding equities should bear in mind a few important considerations. First, any equities--even high-quality companies with above-average dividend yields--are subject to much higher volatility than bonds and therefore shouldn't be used to completely supplant fixed-income investments. Yield-rich equities will often lose less than the broad market during downturns, but they'll still incur losses. Additionally, high-yielding stocks may well get knocked down a peg or two when bond interest rates jump up, as bonds present a more compelling alternative at such times. Finally, it's worth noting that dividend strategies won't typically be the most tax-efficient around. If you're holding them in a taxable account, you'll have to pay taxes on those dividends as you receive them; some yield-focused mutual funds also dabble in securities such as convertibles and REITs, the income from which is taxed at investors' ordinary income tax rates. (Since 2003, qualified dividends have been taxed at the same rate as long-term capital gains, currently 15% for most investors.)

Those caveats aside, here's a closer look at Morningstar analysts' favorite higher-yielding stock funds and ETFs. Premium users can click  here to see a screen I ran to unearth traditional yield-focused mutual funds; note that some otherwise-solid yield-focused funds, such as  American Century Equity Income (TWEIX), didn't clear my modest, 2.5% yield hurdle, an indication of just how far dividend yields have fallen.

Actively Managed Options

 Allianz NFJ Dividend Value (PNEAX)
Category: Large Value 
Analyst Rating: Silver
30-Day SEC Yield: 3.17%

This fund combines dividends and attention to valuation: Analyst Leo Acheson notes that its price/projected earnings ratio is among the lowest of any large-cap value fund's. That strong value bias has crimped results recently; 2015 was a particularly weak campaign as stakes in retailers like  Macy's (M) and Wal-Mart Stores (WMT) weighed on results. Nonetheless, the fund's process has stood the test of time; Acheson notes that it has outpaced its peers and the Russell 1000 Value Index since its 2000 inception. The fund is available without a load or transaction fee on brokerage platforms such as Schwab's.

 Vanguard Equity-Income (VEIPX)
Category: Large Value
Analyst Rating: Silver
30-Day SEC Yield: 2.73%

In the current era of incredible shrinking yields, this fund has an important advantage relative to other yield-focused equity funds: its ultralow expense ratio of just 0.26% for the Investor share class and 0.17% for the Admiral shares. That's a crucial benefit because a fund's expense ratio is deducted first from its yield and secondarily from any gains it makes; a lower expense ratio means a manager doesn't have to take outsized risks to deliver higher yields than competing funds. Wellington Management runs roughly two thirds of the portfolio, while Vanguard's in-house quantitative equity group manages the remainder. In contrast with the aforementioned Allianz fund, Vanguard Equity-Income has enjoyed soaring performance; those who believe in reversion to the mean (and every sober-minded investor should) will want to keep their near-term return expectations in check. 

Index Funds/ETFs

 Vanguard High Dividend Yield ETF (VYM) 
Category: Large Value
Analyst Rating: N/A
30-Day SEC Yield: 3.10%

When it comes to yield-focused ETFs and index funds, Morningstar's director of global ETF research Ben Johnson describes this fund is "as good as they get." Available as either an exchange-traded fund (VYM) or traditional index mutual fund (VHDYX) with a slightly higher (but still ultralow) expense ratio, it tracks the FTSE High Dividend Yield Index. That benchmark encompasses higher-yielding stocks weighted by market capitalization, a construction method that gives the fund a greater focus on consumer-defensive stocks and an underweighting in financials names relative to other large-value vehicles. Like Vanguard Equity-Income, this fund's near-term results have been very strong, so investors would do well to approach it with realistic near-term return expectations. 

Christine Benz has a position in the following securities mentioned above: WMT. Find out about Morningstar’s editorial policies.