As a dividend growth investor, I vastly prefer to cherry pick stocks by myself than to invest in mutual funds for a number of reasons. One of these reasons will be discussed here. But, I understand that many don’t have the time or the interest in the subject for picking stocks themselves. They prefer to rely on “professional” mutual funds managers to do that job for them.
Unfortunately, I truly believe that we are better served by ourselves most of the times.
But, since I love the dividend growth investing strategy, I have decided to compile a small list of dividend growth investing mutual funds that are out there to see what they offer, what their dividend growth looks like and if a dividend growth fund could replace an entire handmade dividend growth investing strategy. Because, if it’s the case, then why bother picking stocks one by one?
Let’s see what are the best dividend mutual funds out there and find out if they would provide a good replacement for my dividend growth investing strategy :
Dividend growth investing strategy explained :
In my own opinion, the dividend growth investing strategy is very simple and robust and it is also based on sound investing principles.
Similar to real estate investing
I often compare dividend growth investing to investing in a rental apartment when I discuss the strategy with my friends or colleagues. You buy a condo unit (here it’s a share) and you rent the unit. The rent is the income you make every month. Since the rented condo unit provides you with income, you wouldn’t sell it. Instead, every year, you would increase the rent and as such, increase your income. Ideally, if it’s possible, you would increase it at a rate higher than inflation every year so that your income is not only protected against inflation but that it will also rise over time.
Every year, your condo unit would be worth more and more mainly because the income it can generate is growing. Everybody wants passive income after all and that’s exactly what it is.
Dividend growth is the key to passive income
The same happens with the dividend growth investing strategy. Instead of purchasing a rental apartment, you purchase a share (part ownership) of a great company paying a dividend. Every year, the company rises its dividend at a rate higher than inflation. There are tons of companies paying growing dividends every year.
That’s one of the best kept secret of Wall Street! Dividend growth is the key!
Since the dividend is higher, the share will also be worth more because there are millions of people out there who want to buy the income. So the dividend growth drives the price higher and as such act as a protection net for the capital and also as an engine driving the capital growth higher and higher.
If you buy enough of these shares and diversify over enough companies, than you’ll build yourself a real cash cow delivering rising income every year.
To summarize, the dividend growth investing strategy is supposed to provide you with steady and growing passive income.
Reinvest the dividends to boost your income
Like a real estate investor would do, you can reinvest the dividend into buying other shares of great companies paying growing dividends. These will act as new rental apartments for you and they will add to your income. This will leverage your portfolio and increase your income at the speed of light! Well… maybe not that fast, but it will help boost your income for sure! That plain compounded interest at its best.
For a complete explanation of the dividend growth investing strategy, you can consult my infographic here or buy Lowell Miller’s book about dividend growth investing. That’s the best book out there. Just my two cents!
Best dividend growth investing mutual funds :
With the gain in popularity of the dividend growth investing strategy, many mutual fund managers out there have decided to create mutual funds and claim that they mimic the dividend growth investing strategy. Let’s see what they look like and if it’s true.
Vanguard Dividend Growth Index (VDIGX)
Based on Vanguard :
This fund is designed to provide investors with some income while offering exposure to dividend-focused companies across all industries. The fund focuses on high-quality companies that have both the ability and the commitment to grow their dividends over time.
The vanguard dividend growth index fund is currently rated 4 stars by Morningstar and based on Vanguard’s website, 10,000$ invested in 2004 would now be worth 24,732.79$. This would have given the investor a CAGR (compound annual growth rate) of 9,48%. Not bad!
Now let’s see what the dividend growth graph looks like (from BuyUpside.com) :
Well… One of the most important aspect of the dividend growth investing strategy is to be able to see rising income year over year. That’s clearly not what this graph shows… As a dividend growth investor, I want to be able to live off my dividend income as a real estate investor would do from his rising rent income. I also want my income to grow at least as fast as inflation. It seems that this fund wouldn’t achieve that.
Let’s look at Wal Mart’s (WMT) dividend graph just for fun (from Buyupside.com):
This is what we, dividend growth investors, prefer to see! Rising dividend equals rising passive income for us! Also note that you would have earned a 7,25% compounded annual growth rate plus the dividend if you would have invested in Wal Mart 10 years ago. You could have spent or reinvested those dividends to boost your return and increase your CAGR (compounded annual growth rate).
The Vanguard dividend growth index fund has paid a dividend since 1992 and based on BuyUpside’s calculator, it’s dividend growth rate has been a poor 2,35%. Worse, the dividend is pretty unstable and varies a lot from year to year so we can’t even count on that 2,35% growth of the dividend.
Wal Mart has paid a dividend since 1974 and the dividend growth rate has been an incredible 23,12% per year over that time period. Wal Mart has raised its dividend every year since 1974. That’s exactly what a dividend growth investor seeks for : growing passive income!
Franklin Managed Trust Rising Dividends Fund Cl A (FRDPX)
Based on Franklin :
The fund seeks long-term capital appreciation by investing at least 80% of its net assets in companies of any size that have paid consistently rising dividends.
This fund is currently rated 3 stars by Morningstar and based on Franklin’s website, 10,000$ invested in that fund in 1987 would be worth 125,171$ today. This gives compounded annual growth rate of 9,81%. Again, this is pretty good. But, to compare it with the others, if you would have invested at the end of 2004, then your CAGR would have been 7.05% for the last 10 years.
Now, let’s look at the dividend growth income graph (from BuyUpside.com) :
Again, while the dividend is pretty steady and while the compounded annual growth rate is not that bad, the dividend growth or the passive income you would get from investing in this fund is far from what a dividend growth investor would like to see.
Now, for fun, let’s see what the Johnson & Johnson’s (JNJ) dividend growth graph looks like (from BuyUpside.com):
Ahhh!! It looks so much better!
If you would have invested your hard-earned money in JNJ in 2004, your return would have been 8,26% plus the rising dividend. JNJ has paid and rise its dividend since 1970 at a compounded annual growth rate of 13,87%. This means that your dividend income would have increased by 13,87% per year during that period of time.
Fidelity Dividend Growth Fund (FDGFX)
Based on Fidelity’s website :
Normally investing at least 80% of assets in equity securities. Normally investing primarily in companies that pay dividends or that FMR believes have the potential to pay dividends in the future. Investing in either “growth” stocks or “value” stocks or both. Normally investing primarily in common stocks.
Morningstar currently rates it 3 stars and based on Fidelity’s website, since 1995, this fund has returned 10.95% per year. Now, if you would have bought shares of this fund 10 years ago in december 2004, you would have received a 6,98% compounded annual return.
Let’s see what the dividend growth graph looks like (from BuyUpside.com):
Again, it’s far from being impressive from the point of view of a dividend growth investor. Dividend distributions are not steady and growing. They vary a lot from year to year.
For fun, let’s compare that to the dividend growth graph of Exxon (XOM) taken from BuyUpside.com website :
How lovely is that? Dividend distributions consistently rising! You would have had a compounded annual growth rate of 8,68% plus the dividend if you would have invested in Exxon ten years ago. Exxon has paid and rise its dividend every year since 1970 and its dividend growth rate per year stands at 7,45% on average.
Vanguard Equity Income Fund Investor Shares (VEIPX)
This fund is designed to provide investors with an above-average level of current income while offering exposure to the stock market. Since the fund typically invests in companies that are dedicated to consistently paying dividends, it may have a higher yield than other Vanguard stock mutual funds. The fund’s emphasis on slower-growing, higher-yielding companies can also mean that its total return may not be as strong in a significant bull market.
Morninstar currently rates it 5 stars. A dollar invested in VEIPX in 2004 would have compounded at an annual growth rate of 8,06%, pretty in line with the other funds here.
Now let’s see what the dividend growth looks like (from BuyUpside.com):
Again, while providing investors with a dividend, the dividend distribution is not growing as we would expect from a dividend growth investing strategy.
For fun, let’s now look at 3M’s (MMM) dividend growth graph :
Again, it looks much better and a dollar invested in MMM 10 years ago would have compounded at a 10,12% rate per year plus the dividend!!! MMM has paid and raised its dividend every year since 1970 at an 8,03% compounded annual growth rate.
T. Rowe Price Dividend Growth Fund (PRDGX)
Based on T.Rowe’s website :
The fund will normally invest at least 65% of its total assets in stocks, with an emphasis on stocks that have a strong track record of paying dividends or that are expected to increase their dividends over time.
Morningstar currently rates this fund 3 stars out of 5. A dollar invested in the fund in 2004 would have compounded at an annual growth rate of 7.64%.
Now let’s look at its dividend growth graph from BuyUpside.com :
Again, it is not the kind of graph that a dividend growth investor would look like. The dividend varies a lot from year to year and is clearly not growing.
Let’s look at the dividend growth graph of Procter & Gamble (PG) just for fun :
How sweet is it? A dollar invested in 2004 in PG would have compounded at an annual growth rate of 8,31% plus the growing dividend. PG has paid and raised its dividend every year since 1970 at a compounded annual growth rate of 9,71%. This mean that your income would have increased by 9,71% per year every year!
While these best dividend mutual funds borrow the name “dividend growth” I feel that they don’t provide what’s most interesting about that strategy. They provide an interesting CAGR on capital for sure but the core of this strategy is based on the growth of passive income, not the growth of capital. Dividend growth investors don’t usually plan to sell their stocks to pay for living expenses, they instead plan on keeping their portfolio intact and living off the rising dividend income. This is not what we can find here…
And if we compare this strategy to a simple index investing mutual funds strategy, one would probably be better off investing in an index fund. Again, I’m not a professional, but I think that these graphs and numbers talk by themselves.
Any comments about the best dividend mutual funds? What do you think of the dividend growth investing strategy? Do you prefer to handpick your stock or to rely on professional fund managers? Do you prefer index investing and if yes, how do you plan to turn your index fund into income at retirement?
I am not a profesionnal or registered advisor. I’m a plain and ordinary guy pursuing a dream, the dream to retire early and live off my dividends. These are not recommendations to buy or sell mutual funds.
Full disclosure : long WMT, XOM, JNJ
* All the calculations and data for this post comes from Yahoo Finance, BuyUpside, Morningstar and the best dividend mutual funds respective companies. All these names are Trademarks owned by their respective owners.
Featured post image courtesy of JScreationsZS / FreeDigitalPhotos.net
Graph images courtesy of BuyUpside.com