mutual funds

Best Funds for Dividends Other Than Vanguard Dividend Growth

Even though Vanguard Dividend Growth has closed to new investors, plenty of good low-cost ETF options remain.

Vanguard did the right thing closing Vanguard Dividend Growth (VDIGX) to new investors. The fund has swollen to $30.6 billion in assets, threatening its ability to continue posting top-notch results.

The mutual fund offers just about everything I look for: low costs, high-quality stocks, a sensible strategy, relatively low volatility and solid risk-adjusted returns. Investors fortunate enough to own the fund should hang onto it; it remains my top pick among dividend-oriented funds.

Don’t confuse a dividend-growth approach with a high-yield strategy. The Vanguard fund yields just 1.9%, after deducting annual fees of 0.33%, a dirt-cheap expense ratio for an actively managed fund. For that price, Vanguard gives you one of Wellington Management’s best managers, Donald Kilbride, and a team of analysts. Unlike most other low-cost dividend funds, this one has humans at the tiller. Kilbride keeps a compact portfolio of roughly 50 stocks. He looks for companies with healthy balance sheets and a history of delivering steadily rising dividends. But he also invests in companies with short payment histories that he thinks will continue to boost dividends in the future.

Investing in dividend-paying stocks makes good sense. If a company is willing to let you share in its profits, odds are that it’s more shareholder-friendly and more stable than other companies.

Dividend payers generally hold up well in down markets, though not always. Any strategy can become too popular, and thus the stocks that adhere to it can become overvalued. Dividend strategies tend to lag in bull markets. They also tend to trail in periods when interest rates are rising.

Thanks largely to the relentless competitive pressures on fees, especially among exchange-traded funds, there’s no shortage of good alternatives to the Vanguard fund. Below are my four picks, all ETFs, in the order that I prefer them. As you’ll see, I prefer dividend-growth over high-yielding dividend funds because I believe they offer a better way to isolate steadily growing companies. Prices and returns are as of August 9.

Schwab U.S. Dividend Equity (SCHD, $42.57) has posted the best returns of the three dividend-growth ETFs in this article. From its inception in late 2011, the fund returned an annualized 14.9%, compared with 15.4% for Standard & Poor’s 500-stock index and a smidgen better than Vanguard Dividend Growth. The fund charges a minuscule 0.07% annually and has been slightly less volatile than the S&P 500. It yields 3.1%.

Schwab tracks the Dow Jones U.S. Dividend 100 index, which uses several criteria to target high-quality dividend payers. It starts with the 2,500 largest U.S. companies, excluding master limited partnerships and real estate investment trusts. Companies must have paid dividends in each of the past 10 years. The index excludes the 50% of companies with the lowest dividend yields. The top-rated 100 stocks are then weighted by market capitalization.

Like most ETFs, iShares Core Dividend Growth (DGRO, $28.08) tracks a benchmark of sorts, in this case Morningstar’s U.S. Dividend Growth index. Morningstar starts by excluding stocks that pay especially high yields—those in the top 10% based on yield—because those stocks are sometimes prone to dividend cuts. Morningstar then screens for companies that have raised their disbursements for at least five straight years and that pay out less than 75% of their earnings in dividends. It weights stocks by market cap and invests no more than 3% in any individual stock.

The result is a portfolio of roughly 425 stocks, almost all of them blue chips. The ETF charges just 0.12% annually and yields 2.4%. Since its inception in mid 2014, the fund has returned an annualized 8.5%, compared with 7.5% annualized for the S&P.

Vanguard Dividend Appreciation (VIG, $85.57) has the most stringent rules of the three dividend-growth funds. The ETF tracks the Nasdaq U.S. Dividend Achievers index, which looks for companies that are capable of continuing to increase their dividends. The index includes only companies that have hiked their dividends in each of the past 10 years.

The ETF contains 185 stocks. It charges just 0.09% annually and yields 2.1%. Over the past 10 years, VIG returned an annualized 8.0%, compared with 7.9% for the S&P.

As its name indicates, Vanguard High Dividend ETF (VYM, $73.04), my last pick, focuses more on generating high income than on dividend growth. That said, the fund’s current yield, 3.1%, is the same as that of Schwab U.S. Dividend Equity. After excluding REITs and small-cap stocks, the Vanguard ETF takes the 50% of dividend payers with the highest yields and weights them by market cap. Over the past five years, the ETF returned an annualized 16.0%—an average of 0.3 percentage point per year more than the S&P 500. The fund charges 0.09% per year.

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