For many people, the reliability of dividend or interest income is one of the primary benefits of investing. Unlike individual stocks and bonds, mutual funds can be a great source of dividend income. However, not all mutual funds pay dividends, so if generating regular dividend income is important to you, find out which types of funds pay the highest dividends.
Dividend Stock Funds
For those who primarily want to generate regular dividend income but are willing to take some risk for the opportunity for capital gains, stock funds can be an excellent choice. These funds focus on investing in stocks that have reliable records of paying healthy dividends every year. Since paying dividends to shareholders is considered a sign of a company’s financial stability, many companies boast of increasing profits each year.
Dividend funds aren’t focused on identifying the next Wall Street bull, but all stock investments have the potential to go up or down in value based on market fluctuations and the performance of the producing company. While a dividend fund is not focused on generating capital gains, the stock of a healthy company that pays high dividends can increase the value of the fund over time.
Dividend Bond Funds
Unlike stock funds, dividend distributions made by bond funds are the result of interest income generated by the bonds in the fund’s portfolio. The interest rate, or coupon rate, paid on a bond is influenced by many factors, including the credit rating of the issuer and national interest rates at the time of issuance. While the bond yields of more stable, creditworthy corporations and governments tend to reflect rates set by the Federal Reserve, less stable entities often issue bonds because of the greater risk of defaulting on their financial obligations.
High-yield dividend bond funds invest in very low-rated bonds because they pay very high interest rates to compensate for the risk of default faced by financially unstable issuers. Although the dividend income from these types of funds can be high, they are at high risk. Other low-risk bond funds distribute more moderate dividends but have much lower risk of default.
Counseling awareness
Dan Danford, CFP®
Family Investment Center, St. Joseph, MO
Many people think of investing as a bank account. So, they automatically ask about interest rate, dividend or dividend rate. However, interest or dividend payments are only part of the total value-added, as investment returns are also a large part of the equation.
Total return is a calculation that takes all these factors into account. This is important because many high-quality investments do not provide regular income. Most large companies, for example, pay relatively low dividends even though their share prices may increase over time.
Of course, this can be good for investors because the dividends are taxed and the stock price growth is not until they sell the shares. So, if you really want growth, look for investments that generate total income.
