Diversification with dividend funds
What are dividend funds?
With a dividend fund, investors have the opportunity to invest in a portfolio of equities with the highest dividend yields. In principle, anyone who wants to invest in equities and cannot or does not want to deal with the selection of individual equities is well advised to invest in an investment fund. Here experienced fund managers arrange a stock portfolio after certain criteria, in which the buyers of the fund participate proportionately. The risk of the investor is scattered in such a way on several enterprises and minimized altogether.
Dividend funds, unlike most equity funds, do not have the primary objective of profiting from share price increases. The aim of a dividend fund is to allow investors to participate in an annual and steadily rising dividend distribution. Dividend funds thus combine the advantages of a dividend-oriented investment strategy with those of a diversified equity investment. Equities from defensive sectors are preferred for inclusion in dividend funds. These are sectors that are comparatively subject to low price volatility in economically weak market phases, such as the healthcare industry or consumption industry. Although these sectors benefit only insignificantly from economic upswings, they fit well into a dividend-oriented portfolio due to their consistently distributed returns.
Why investors should invest in dividend funds?
Whoever invests in dividend funds participates in renowned national and international corporations. These are predominantly profitable and healthy companies with mature business models that pay out continually rising dividends. Depending on the investment strategy of the fund management, dividend funds contain not only the most successful dividend shares, the so-called dividend aristocrats, but also established corporate values with longstanding positive dividend histories. Therefore, dividend funds are particularly suitable for long-term investment strategies as well as for investors who would like to receive annual distributions. Long-term asset accumulation is also possible with the help of reinvesting dividend funds. Thus, dividend funds can easily generate returns of between 4 and 8 percent.
Investors should pay attention to this
For dividend funds it is necessary to choose between actively managed and passive index funds (Dividend ETF's). While passive index funds track equity indices exactly, fund managers of actively managed dividend funds choose their securities freely. This has several advantages. The fund management can determine the weighting of its portfolio individually. It incorporates industry considerations and analyses of future profit expectations of individual companies into its buying and selling decisions. Active fund managers do not view dividend yields as an isolated criterion. They analyse business models and select stocks from healthy companies with positive future prospects. They can therefore also better protect themselves from the return trap: Since the dividend yield represents the ratio of the last dividend paid to the current share price, there is an improvement in the dividend yield purely mathematically if the share price falls. However, falling share prices obviously do not speak in favour of a positive future forecast for the company. Accordingly, the sudden improvement in dividend yields represents a warning notice. An active fund management can react quickly to such and other current events and remove stocks from the fund with sharp price drops. An index fund remains rigid here.
The distribution policy of the stock company is another criterion to pay attention to the fund manager of an actively managed dividend fund. Are dividends paid in an amount which the company profits alone do not yield? Are no new reserves formed or even loans taken up to finance dividend distributions? In the short term, active fund management can minimise risks. In the long term, however, only a few actively managed dividend funds can outperform the respective index. The risk of outperforming the index due to management mistakes is high. The costs for an actively managed dividend fund are also higher than for a pure ETF index fund. To be mentioned here are the issue premium and the annual management fees, which are charged to the fund performance.
Dividend yield as an alternative to interest rate products?
In view of the low yields on the bond market, investing in dividend funds is a alternative for many investors. However, this is a very simplified idea. The opportunity/risk ratio of equities and interest-bearing investment products differs greatly from one another. While the investment in interest rate products entails a calculable and comparatively low risk, an investment in equities is always a high-risk and incalculable corporate investment. Buyers of dividend-oriented equity fund units participate in the company's profit or loss. Dividend funds are sometimes subject to greater price fluctuations than other equity funds. Neither the share price nor future profit distributions can be accurately predicted. These are merely estimates and assumptions, usually based on assessments of the historical development of the company. How fast the profit prospects of a company can change, however, can be illustrated by the automotive industry. Nevertheless, equities belong in a diversified investment portfolio and via dividend funds this is possible with an optimal risk diversification.