In the past few years, with interest rates so low, investors have flocked to mutual funds that focus on dividend-paying stocks as a way to squeeze out income. But not all dividend-focused funds are created equal.
Today it’s best to seek funds that concentrate on stocks whose dividends are most likely to grow substantially rather than stocks with the greatest yields. That way, as interest rates rise, which they are expected to do over the next several years, and as the economy picks up steam, these funds will offer some protection against inflation.
If, instead, you stick with the highest-yielding stock funds, you are taking a greater risk. Some of the companies they invest in are paying out more in dividends than their earnings justify, so these dividends could be pared back or even eliminated. And some are large, slow-growth businesses such as telecommunications firms and utilities. As interest rates rise, investors may abandon these in favor of bonds with higher yields.
In contrast, some of today’s stocks with great dividend-growth potential still are bargains, and they typically are in sectors that take off in a stronger economy, such as technology, energy and materials. Three top mutual funds that focus on dividend growth…
Nichols Equity Income Fund (NSEIX) seeks small- and midsize companies that have annual earnings growth of 10% or more.
TCW Dividend Focused Fund (TGIGX), an aggressive fund, looks for large, undervalued companies with clear catalysts to increase earnings.
Vanguard Dividend Growth Fund (VDIGX) mixes high-quality companies that have long histories of annual dividend increases with firms that are starting to raise dividends.