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Which Type of Dividend Fund Do You Prefer?

They may carry the same name, but not the same investment approach.

Illustrative photograph of John Rekenthaler, Vice President of Research for Morningstar.
Securities In This Article
WisdomTree US LargeCap Dividend ETF
(DLN)
WisdomTree US High Dividend ETF
(DHS)
ALPS Emerging Sector Dividend Dogs ETF
(EDOG)
iShares Core High Dividend ETF
(HDV)
AAM S&P 500 High Dividend Value ETF
(SPDV)

The ETF Advantage

Last week’s column “Are Dividend Funds All That?” showed that equity funds that hold dividend-paying stocks have thrived over the long term. Usually, bear-market heroes are bull-market flops, but dividend funds have been exceptions. They not only have resisted downturns but have also profited from stock rallies. (This discussion assumes that investors are using tax-sheltered accounts. Because dividend funds are tax-unfriendly, they are ill-suited for taxable accounts.)

Thus, unlike with my usual fund discussions—which conclude that nobody needs those investments—dividend funds deserve further consideration. Their strategies reside on a spectrum. Some dividend funds seek high upfront income, while others favor companies that pay moderate but growing dividends. This article evaluates each approach, then finishes by recommending the top candidates.

One hundred twenty-seven U.S. equity funds have “dividend” in their names. Seventy-two are mutual funds, while 55 are exchange-traded funds. Here are their median results.

A table showing the number of funds, mean 10-year total return, median current income, and median expense ratio for all U.S. stock funds with dividend in their names, sorted by: 1) mutual funds and 2) ETFs.

As the mutual funds are almost all actively run, and 80% of the ETFs are indexed, these totals do not reflect well on active management. Not only are ETFs cheaper, but most have outgained mutual funds by even more the cost difference, and they currently outyield them by greater than that amount as well.

Current Income

Dividend funds offer a range of yields. The following chart shows the 90th, 75th, 25th, and 10th percentiles for their current income, along with the median result.

A bar chart showing the 90th, 75th, 50th, 25th, and 10th percentile results for current income, for all U.S. stock funds with dividend in their names.

Unsurprisingly, most of the top-paying funds style themselves as “high dividend.” Examples include iShares Core High Dividend ETF HDV and AAM S&P 500 High Dividend Value ETF SPDV, which neatly illustrate the two prevailing approaches. The iShares fund owns shares from industries that pay well; consequently, half its assets are in energy and healthcare companies. In contrast, the AAM fund diversifies across sectors, selecting from among the highest-yielding businesses in each industry.

Such funds tend to have low costs. Because funds initially pay their expenses from income, dipping into their capital only if required, their outlays directly reduce yield—a painful penalty for investments that boast about their distribution rates. Consequently, most “high dividend” funds have expense ratios of less than 0.50%.

Capital Growth

Of course, as dividend funds are far from being the highest-yielding investments—these days, even cash pays more—current income alone is insufficient. If stock prices rise, as has generally been the case in recent years, then dividend funds must increase their net asset values to justify their existence. After all, the reason investors own dividend funds rather than bonds is to boost their capital.

The following chart echoes its predecessor in depicting the various percentiles for dividend funds, but this time it shows capital growth rather than current income.

A bar chart showing the 90th, 75th, 50th, 25th, and 10th percentile results for 10-year capital growth, for all U.S. stock funds with dividend in their names.

These are healthy figures. At the 90th percentile mark, dividend funds have expanded their capital bases by 10.27% per year, for a cumulative gain of 166%. (Their total returns, which include their dividend receipts, are even fatter.) Good work if you can get it! Even the 10th percentile figure offers some comfort, as it represents an 85% increase, although those investors missed an opportunity. Had they invested in other dividend funds, they would be wealthier yet.

Income Growth

The next logical step is to combine current income and capital growth, by calculating what each dividend fund pays based on an earlier investment. That is, rather than show the yield that new investors receive, as the current income chart does, the next exhibit shows the yield obtained by investors who bought their shares in January 2013. This figure, which is stated as a percentage of the original purchase price, incorporates both current income and subsequent growth.

A bar chart showing the 90th, 75th, 50th, 25th, and 10th percentile results for current income based on a January 2013 purchase that was since held, for all U.S. stock funds with dividend in their names.

This range is greater than that of capital growth alone. There is a big difference between the 6.74% distribution rate enjoyed by shareholders who 10 years ago invested in a 90th-percentile fund, and the relatively paltry 2.69% yield received by those in a 10th-percentile fund. The former can be exceeded only by high-risk bond funds, while the latter cannot even match today’s Treasury-bill payouts.

The Best Funds

This information can be used to create two best-funds tables, reflecting the split between funds that seek high current yield and those that favor capital growth. I call the first list “income funds” and the second “total return funds.” (Never accuse me of having an overactive imagination.) Each list scores funds according to 1) their income growth and 2) their expense ratios. Then, income funds are also evaluated by their current income, while total return funds are measured by their capital growth.

Two funds appear on both tables. Appearing in bold type, they should appeal to all dividend-fund investors, regardless of their goals. Finally, all the listed funds are ETFs. As it turned out, no mutual fund could overcome its expense handicap.

Below are the income funds.

A table showing the five leading U.S. stock funds with dividend in their name, as scored by the average ranks of their 1) current income, 2) growth of income over 10 years, and 3) expense ratios.

(Note: I do not provide the various fund ranks, as I find it more useful to show the fund results. But rest assured, the funds are presented in the correct order. Of the 68 dividend funds that existed from 2013 through 2022, Schwab U.S. Dividend Equity SCHD had the highest overall ranking for three stated attributes, iShares Core High Dividend placed second, and so forth.)

Now, let’s see the total return funds.

A chart showing the top 5 U.S. stock funds with dividend in their names, as scored by an average ranking of their 10-year capital growth, current amount of income generated on an investment made in January 2013, and expense ratios.

As there are eight funds in total, I will round out the winner’s list by providing two honorable mentions. Vanguard Dividend Growth VDIGX and Columbia Dividend Income GSFTX just missed qualifying for the Total Return chart, the first because its income growth was only average and the second because of slightly higher costs, but each posted among the group’s strongest total returns. Investors who wish to own conventional mutual funds rather than ETFs should be pleased with either of those options.

The opinions expressed here are the author’s. Morningstar values diversity of thought and publishes a broad range of viewpoints.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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About the Author

John Rekenthaler

Vice President, Research
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John Rekenthaler is vice president, research for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc.

Rekenthaler joined Morningstar in 1988 and has served in several capacities. He has overseen Morningstar's research methodologies, led thought leadership initiatives such as the Global Investor Experience report that assesses the experiences of mutual fund investors globally, and been involved in a variety of new development efforts. He currently writes regular columns for Morningstar.com and Morningstar magazine.

Rekenthaler previously served as president of Morningstar Associates, LLC, a registered investment advisor and wholly owned subsidiary of Morningstar, Inc. During his tenure, he has also led the company’s retirement advice business, building it from a start-up operation to one of the largest independent advice and guidance providers in the retirement industry.

Before his role at Morningstar Associates, he was the firm's director of research, where he helped to develop Morningstar's quantitative methodologies, such as the Morningstar Rating for funds, the Morningstar Style Box, and industry sector classifications. He also served as editor of Morningstar Mutual Funds and Morningstar FundInvestor.

Rekenthaler holds a bachelor's degree in English from the University of Pennsylvania and a Master of Business Administration from the University of Chicago Booth School of Business, from which he graduated with high honors as a Wallman Scholar.

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