To create a dividend mutual fund, whether high dividend or low dividend or anything in between, a mutual fund manager puts together a group of stocks that pays dividends.
With that, let’s take a look at this video from Dividend.com. They talk about dividend stocks, but remember that dividend mutual funds are made up of dividend stocks:
Let me add a couple of points. First, the presenters in this video talk about the relationship between share price and dividend yield. To that, I would add that once you buy the stock, the yield will vary as the stock fluctuates up and down. As you go forward, you will continue to calculate your yield based on what you paid, not what the stock sells for after that.
Second, in searching for dividend mutual funds, you will see references to funds made up of Dividend Aristocrats (definition here). These are stocks that have increased their dividend every year for a minimum number of years. In the United States, that minimum stands at 25 years. Other countries, which may use different names, may have different minimums. In any case, dividend mutual funds with many Dividend Aristocrats will generally be safer than funds without them.
The Concern about High Dividend Mutual Funds
Let’s turn now to the big potential problem with high dividend yields. As the presenters pointed out, yields that get too high also get dangerous (their discussion of this starts around the 4:45 min mark if you want to watch it again). To reiterate, when the price of a stock falls, the yield goes up. When the price of a stock falls, it usually suggests a problem now or in the future.
One of the advantages of shopping for dividends through mutual funds, rather than stocks, is that we have mutual fund managers doing the due diligence for us. They’re professionals and better placed to judge whether a stock has fallen because of a company problem or because of a general market malaise.
As for choosing among high dividend mutual funds, create a short list of candidates, then check their Sharpe Ratios. This ratio will tell you how much reward you’re getting for each unit of risk, allowing you to compare apples with apples among high dividend funds.