Quality matters in a market like this. That's a no-brainer. But how do you know if a stock is "quality"? Dividends are one indicator. That's because dividend income—which is essentially a portion of company profits paid out to shareholders—helps offset fluctuations in a stock's share price, often creating a cushion during volatile markets. Stocks that pay dividends "tend to be very solid, stable types of investments and often end up being the class act of corporate America from an investor's standpoint," says Morningstar analyst Christopher Davis. "These companies ... tend to have some sort of competitive advantage that allows them to generate excess free cash flow that they can distribute to shareholders."
Funds that focus on dividend-paying stocks vary in strategy. Some sit squarely in the value camp and contain bargain-priced stocks with above-average yields. Some search for dividends abroad. Others focus more on future dividend growth than on high current yields. Here is a sampling of funds—including one ETF—that take different approaches to satisfy dividend devotees.
[Slideshow: 7 Great Dividend Funds.]
1. Cullen High Dividend Equity. The managers of U.S. News's top-ranked large-value fund sift through the universe of large companies using several criteria: stocks must have dividend payouts greater than the average yield of the S&P 500, and they must have price-to-earnings, price-to-book, and debt-to-capital ratios below the S&P 500 average. Beyond that, managers James Cullen and John Gould dig into company fundamentals to determine if a company is likely to continually increase its payouts in the future.
The managers also look for opportunities abroad: Currently, nearly 20 percent of the portfolio's assets are in foreign stocks, including multinational giants AstraZeneca and Diageo. Stateside holdings include Boeing, Johnson & Johnson, and Kraft Foods. Cullen High Dividend Equity weathered 2008 better than most large-cap value funds, but it lagged the pack in 2009's rally. Over the longer term, the fund's measured strategy has paid off: Over the past one, three, and five years, the fund's returns rank in the top 20 percent of its category. The fund currently yields 2.37 percent and charges 1 percent in annual fees.
2. Matthews Asia Dividend Fund. Investors may be surprised to learn that Asia boasts some of the highest-yielding stocks in the world. Matthews Asia Dividend proposes a safer way to play this region by investing in companies that pay consistent and growing dividends, which managers Jesper Madsen and Andrew Foster believe "often signals companies that exhibit solid market positions, sustainable business models, and better management teams," according to fund commentary. More than 20 percent of the fund's portfolio is currently dedicated to Japanese companies, which have been improving their dividend policies over the past five years, according to Madsen.
The fund's 2008 loss of 26 percent was significant; still, it bested virtually all of its peers, which suffered an average loss of 43 percent. Over the past one and three years, Matthews Asia Dividend—U.S. News's top-ranked fund among diversified funds that invest in Asia and the Pacific—ranks in the top 1 percent its category, according to Morningstar. The fund yields 3.32 percent and charges 1.30 percent in annual fees.
3. Vanguard Dividend Appreciation ETF. Investors seeking dividends on the cheap might consider Vanguard Dividend Appreciation, an exchange-traded fund that tracks the Dividend Achievers Select Index. Although the fund's 142 stocks are spread across a range of sectors and industries, each member has a history of boosting its dividend payouts over time. A requirement of inclusion in the index—and therefore, the fund—is that companies must have increased their annual dividends for at least the past 10 years. Stocks in the fund typically have ample cash on hand, strong balance sheets, and consistent earnings growth.