Funds that specialize in dividend-paying stocks are a good bet for retirees. 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, essentially creating a cushion during turbulent markets.
So-called equity income funds go a step further: They provide income from dividends but also strive for growth from capital appreciation. "Equity income funds are useful because they give you consistent income but also stock market exposure," says Steven Dimitriou, managing partner of Mayflower Advisers, an investment advisory firm in Boston. The following funds rank among the top performers in Lipper's equity income category over the past five years through July 1:
Amana Income. The category's top-performing fund over the past three and five years invests according to Islamic principles. That means it avoids companies that draw significant revenue from alcohol, tobacco, pork, gambling, or pornography. There's an even bigger twist: The fund rules out companies in the business of borrowing or lending money, so financial stocks, which heavily populate most dividend-oriented funds, are also out. Perhaps the avoidance of financials helps explain why Amana ranks in the top 2 percent of funds that invest in large, undervalued companies over the past year. Manager Nicholas Kaiser buys only stocks that pay a dividend, and the fund is heavy on utility, healthcare, and basic materials stocks. The fund charges 1.38 percent in annual fees, and yields 0.6 percent.
Vanguard Dividend Growth. This actively managed fund focuses on strong, steadily growing companies with a long history of boosting their dividend payouts year after year. When considering a company for the portfolio, manager Donald Kilbride estimates how sizable a dividend it might pay in five years. To do this, he considers the company's dividend history, its free cash flow (a measure of profitability), and the management's willingness to continue raising the payouts. This strategy steers the fund toward industry giants with strong brand names—such as Procter & Gamble and PepsiCo—which tend to hold up in times of market turbulence. The fund, which yields 2.1 percent, levies annual expenses of 0.32 percent.
Parnassus Equity Income. Here's a fund for socially conscious investors. Not only does it screen out companies that make alcohol, tobacco, or weapons, it seeks out those that are environmentally friendly, treat their employees well, and support the communities in which they operate. Manager Todd Ahlsten invests mainly in large dividend payers but also considers midsize and small companies. He evaluates stocks using a handful of measures, such as price-to-book value and also incorporates some big-picture economic analysis. In 2007, Ahlsten avoided financial-services stocks with real estate exposure, which helps explain why it's down just 3 percent over the past year versus a 15 percent loss for the S&P 500. The fund charges 1 percent in annual fees and currently yields 1 percent.
T. Rowe Price Equity Income. It's hard to argue with this fund's exceptionally consistent record. Since its 1985 launch, the fund has lost money in only two calendar years: 1990 and 2002. Manager Brian Rogers, who is also chairman and chief investment officer of T. Rowe Price, often buys out-of-favor companies struggling with temporary setbacks. He also favors stocks with dividend yields higher than the average stock in the S&P 500-stock index. Top holdings currently include J.P.Morgan Chase, Eli Lilly, and Hershey. The $19.8 billion fund, which currently yields 2.4 percent, has gained an annualized 12 percent in the 22 years since its launch. It charges 0.67 percent in annual expenses.
American Century Equity Income. Companies with a history of doling out dividends are the focus at this team-managed fund. Most of the fund's assets reside in large-company stocks, which the managers scoop up on the cheap (according to valuation measures such as price-earnings ratios). The portfolio, which counts ExxonMobil, General Electric, and AT&T among its top-five stocks, also holds sizable stakes in midsize companies and convertible bonds. The fund's long-term results are solid: Its annualized 8 percent return over the past 10 years ranks in the top 2 percent of all funds that invest in large, bargain-priced stocks. Annual fees are 0.97 percent, and the current yield is 3.2 percent.