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SmartAsset: A Guide to Investing in Dividend Mutual Funds

Investors looking for recurring income should consider investments that offer dividends. Dividend investments offer consistent income, an opportunity for asset appreciation and the potential for favorable tax treatment. Dividend mutual funds invest in stocks that pay investors regular dividends. Let’s break down what they are and how to invest in them. A financial advisor could help you create a financial plan for your investment needs and goals.

Why Should You Invest in Dividends?

Here are five reasons why investors choose to invest in dividends over other investments that provide ordinary income or interest payments.

Tax benefits. When you invest in a taxable account, taxes can be a big concern as your investments grow. While distributions from CDs and REITs are taxed at ordinary income tax rates, qualified dividends are taxed at capital gains rates. These rates are substantially lower and are as low as zero, depending on your overall income and tax filing status.

Regular income. Dividends are distributed to investors on a regular basis. These dividend distributions can happen monthly, quarterly, semi-annually or once per year, depending on the company. Some companies have a strong track record of payment consistency, which makes them very appealing.

Potential for increased income. Many companies increase their dividends over time as their profits increase. This provides a consistent dividend yield as their stock price increases and helps investors keep up with inflation.

Appreciation of underlying assets. When you invest in dividend-paying investments, not only do you receive the regular dividend distributions, but you can also benefit from the potential increase in value. While this does not provide immediate income, you can harvest your capital gains by selling the assets in the future.

Dividend reinvestment. Many investors choose to reinvest their dividends to buy more shares of the stocks or mutual funds that distributed the dividends. This grows the value of your portfolio and increases future dividend distributions based on the larger number of shares that you own.

What Are Dividend Mutual Funds?

Dividend mutual funds are funds that focus on investing in stocks that pay dividend income. The mutual fund owns the stocks and receives the dividend income that is distributed by those stocks. It then distributes the dividends to the mutual fund shareholders on a regular basis.

Dividend Mutual Funds vs. Individual Stocks

Dividend mutual funds offer numerous benefits to investors over individual stocks, but there are some disadvantages as well. Review these pros and cons before choosing which type of investments to earn dividends from.

Pros

  • Instant diversification. When investing in a mutual fund, you receive instant diversification in a number of stocks, even when you start out with a small investment amount.
  • Professional management. Mutual funds offer professional management that analyzes each investment carefully which is often unmatched by the average investor picking individual stocks by themselves.
  • Easier to track. When you invest in a single mutual fund, it is easier to track your shares and performance much easier than if you owned numerous individual stocks.

Cons

  • Taxed as ordinary income. When you receive dividend income from a mutual fund, these distributions are taxed as ordinary income. This negates one of the biggest benefits of investing for dividend income.
  • Cannot choose investments. As a mutual fund investor, you cannot choose the individual stocks that the fund manager invests in. Plus, mutual funds typically disclose their portfolio only once a quarter, so you may be choosing a fund based on outdated information.
  • Cannot strategically sell individual investments. If you want to harvest a loss on an individual stock or cycle out of a specific niche or investment, you cannot do that with a mutual fund. The fund manager controls all investment decisions.

Bottom Line

SmartAsset: A Guide to Investing in Dividend Mutual Funds

Dividend mutual fund investing offers several benefits for investors, but some drawbacks as well. These investments can be a valuable piece of your overall strategy, but it helps to speak with a financial advisor to understand how best to approach them to meet your investing goals.

Tips for Investing in Dividend Mutual Funds

  • A financial advisor can help you develop an income strategy using dividend mutual funds, REITs and other assets to meet your retirement goals. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Dividends contribute to the overall returns that you can earn on your investments. Reinvesting mutual fund dividends can accelerate the growth of your investment portfolio. Our investing calculator allows you to forecast how big your portfolio can grow by adjusting contributions, rates of return and investing timeframe.

Photo credits: ©iStock.com/Deagreez, ©iStock.com/Ridofranz, ©iStock.com/Tijana Simic

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