Dividend paying stocks are the Tom Hanks of investing – everyone seems to love them.
Many retirees rely (at least in part) on the regular income that dividend-paying stocks generate. Non-retirees, on the other hand, enjoy “getting paid to wait” – or the idea of receiving quarterly income on stocks while clinging to appreciation in stock prices. Historically, dividends have been a key component of total returns, although this impact has been mitigated in recent years as low- and no-growth stocks have generated much of the market’s return.
There are many dividend-focused mutual funds and exchange traded funds to choose from. Today we’re shining the spotlight on some that focus on dividend-paying US stocks that achieve Morningstar Silver Analyst Ratings or better. (We expect these well-rated funds to outperform over a full market cycle.)
Not all dividend funds are created equal. Most of the funds on this list pursue one of two approaches to dividend paying stocks.
The first group favors what Morningstar’s global director of passive strategy research, Ben Johnson, has called “returners,” stocks with high returns in absolute terms. These companies are generally more mature companies that choose to pay out profits rather than reinvest them. You will find these returns primarily in the finance, energy, utilities, and industrial sectors. These stocks have attractive returns but come with some risk. For starters, producers in economically sensitive sectors may be vulnerable in the event of an economic downturn. Additionally, producers face interest rate risk: When rates rise, investors can trade high-income stocks, especially in industries like REITs and utilities, for bonds.
The second group of funds focuses on what Johnson calls “producers” – companies that have increased their dividends over time. Growers don’t usually brag about robust yields the way growers do, although they do have their advantages. Notably, companies that steadily increase their dividends are generally profitable and financially sound. As such, these companies tend to show some resilience during market downturns. In addition, stocks with increasing dividends may offer some protection against inflation. “Income-oriented investors get a small ‘raise’ when a company raises its dividend,” said Christine Benz, Morningstar’s director of personal finance.
Deep dive: What is the difference between dividend yielding and dividend growing stocks?
Of course, none of the dividend-driven strategies excel in all market climates. “Overall, however, they tend to hold up a bit better than average in times of market turmoil and have generated attractive risk-adjusted returns over longer periods,” notes Amy Arnott, portfolio strategist at Morningstar.