Dividend Funds the Beginning Investor’s Second Friend

In my last article Vanguard the Beginning Investor’s First Friend, I discussed 8 Vanguard growth funds and their respective appreciation over the past decade.  I also talked about how money kept in a savings account would have vastly underperformed these 8 growth funds and inflation.  To find a compromise between the safety of a savings account and the risks involved with a growth fund, I will introduce the idea of dividend funds.

First off, a dividend fund is defined by Investopedia as “seeking to provide investors with income from common and preferred shares of stock which yield dividends in cash and stock on a regularly-occurring basis.  It is the opposite of a growth fund, which seeks to provide investors with long-term appreciation of capital.”

One attribute that dividend funds offer investors, is a monthly/quarterly/semi-annual dividend payment which is made out to the fund holders.  This can serve as a great source of income or if one signs up for a dividend reinvestment plan, the received payment/income will go back into the stocks.

Now to visually highlight the capital appreciation (starting with $10,000) in the past decade among 4 top dividend fund, I’ve made a chart shown below.  The 10-year annual rate of returns for each fund are:

  • Vanguard Dividend Appreciation ETF (VIG) 10-year annual rate of return = 15.08%
  • Fidelity Equity Dividend Income Fund (FEQTX) 10-year annual rate of return = 14.25%
  • Vanguard Equity Income Fund (VEIPX) 10-year annual rate of return = 16.23%
  • Fidelity Strategic Dividend & Income Fund (FSDIX) 10-year annual rate of return = 15.07%   

*The expense ratio for VIG is 0.08%, FEQTX is 0.62%, VEIPX is 0.27% and FSDIX is 0.72%

If we calculate the real rate of return we can also find the appreciation percentage after inflation.  Recall that inflation over the past decade is 19.5268%. Hence, each individual funds real rate of return is:

  • Vanguard Dividend Appreciation ETF (VIG) real rate of return = 257.38%
  • Fidelity Equity Dividend Income Fund (FEQTX) real rate of return =233.24%
  • Vanguard Equity Income Fund (VEIPX) real rate of return = 292.65%
  • Fidelity Strategic Dividend & Income Fund (FSDIX) real rate of return = 256.57%  

The separation between dividend funds and equity growth funds, is the stocks in the portfolio.  Dividend stocks, which make large quarterly payments to shareholders, are typically more stable in price.  For example, in the past three years Coca-Cola (KO), which pays a current 3.49% dividend yield, has fluctuated in a price range from $45.60 to roughly $50.15.  That means in the past three years, Coca-Cola’s stock price fluctuation has never exceeded 10%. Now take Tesla (TSLA), which is held by a significant number of U.S. growth equity funds.  In the past three years, price fluctuation has occurred in a range of $232.74 to $383.45. Note that the current share price is $275.80, but this means in the past three years Tesla’s stock price fluctuation has seen a range of roughly 65%.  Also, Tesla does not pay a dividend.

So what does this all mean?  First note that the Tesla example is why fund managers practice diversification, which I described in my previous article Vanguard the Beginning Investor’s First Friend, this allows for pooled investments to experience significantly decreased volatility by investing in different areas of a market.  The same principles of diversification apply to dividend funds, but due to the relative stability associated with companies like high-dividend paying companies like Coca-Cola (KO), Lockheed Martin (LMT) and certain banks, volatility is typically decreased to more of an extent than what’s seen in the stocks sometimes included in growth funds.     

Lastly, one of the biggest attributes of a dividend fund is income in the form of a yield.  A mutual fund’s ttm yield refers to the percentage of income (dividend payments) the fund returned to its investors over the past 12 months.  As to why this ttm yield, in certain situations, can be beneficial, let’s examine the Vanguard Equity Income Fund (VEIPX). This dividend fund has a ttm yield of 2.67%, which means if one currently has $1,000,000 invested into VEIPX, they would have received a dividend payment of $26,700 over the past 12 months.  Hence, funds with high ttm yields can be great secondary sources of income for investors, while still providing them with long-term growth and an added layer of financial safety.

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