Our Favorite High(er)-Yielding Equity Funds and ETFs

This article is part of Morningstar's Guide to Dividend and Income Investing special report. A version of this article appeared in August 2016.

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. "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

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. Additionally, high-yielding stocks may well get knocked down a peg or two when bond interest rates rise, as bonds present a more compelling alternative at such times. Not surprisingly, as rates have ticked up during the past year or so, yield-rich utilities and REITs have lagged. 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 some of Morningstar analysts' favorite higher-yielding stock funds and ETFs that carry SEC yields of 2.5% or better. Note that some otherwise-solid yield-focused funds, such as

Actively Managed Options

Category:

Large Value

Analyst Rating:

Bronze

30-Day SEC Yield:

2.53%

This portfolio maintains a mix of dividend growers and dividend yielders, but management favors the latter. The fund focuses on stocks with market capitalizations greater than $300 million, with a goal of outperforming the Russell 3000 Index while delivering a yield that's 150 basis points higher. Though the fund has generally performed well--lagging a bit in rallies but holding up relatively well in less-hospitable markets--fees could be lower.

Category:

Large Value

Analyst Rating:

Silver

30-Day SEC Yield:

2.63%

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 outsize 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. Vanguard Equity-Income has enjoyed soaring performance over the trailing three-, five-, 10- and 15-year periods; 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 Fund/ETF

Category:

Large Value

Analyst Rating:

Silver

30-Day SEC Yield:

2.96%

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.