Are dividend funds right for you? Shark Tank’s Mr. Wonderful thinks so

Kevin O'Leary

Source: Ontario Chamber of Commerce via Flickr

Kevin O’Leary, aka Mr. Wonderful of Shark Tank fame, recently created a dividend focused ETF fund. Dividend yielding funds are quite popular these days; they typically provide higher yields than broad-based index funds, but are they for everyone?

We have been proponents of index funds for most people for a long time; such funds offer easy access to the stock market by tracking a large swath of the overall market; S&P 500 index funds track those funds that are members of the S&P 500, a group of 500 of the largest U.S. based publicly traded companies.

Indexing is the way to go…
Index investing has gain in popularity over the years. John Bogle, the founder of Vanguard Investing, has been a huge proponent of index funds for decades. Recently many individuals, corporations, and municipalities have moved a significant portion of their investments into index funds. Since index funds, by their charter, track the portion of the stock market that they are associated with, they won’t outperform subset of the market; if the S&P 500 goes up 1% today, those funds that track the S&P 500 will also gain about 1%. Of course, if the S&P 500 declines, those associated funds will also decline; they track the index and won’t gain or lose more than the market. Passively managed index funds might not have the ability to outperform or under-perform the market, however the same can’t be said about actively managed funds; those which have professional investors making decisions. Four out of five actively managed funds under-perform the overall market. That said, there may be a class of managed funds which might be worth further consideration, especially amongst retirees seeking income.

But what if you need a little extra cash…
Retirees, and anyone else who might be seeking income, have looked for alternatives to bonds given the extremely low interest environment that we’ve been in for years. Many investors have sought alternatives to bond in dividend paying stocks. There are many high-quality individual stocks which have been paying reasonable dividends for many years; decades actually. There is a group of Dividend Aristocrats, companies that have not only been paying dividends every year; they have been increasing their dividend each and every year. These Dividend Aristocrats have increased their dividends each and every year for at least 25 years; some of those companies have been increasing their dividends for 50 years or more. Investing in individual stocks, even those that have been increasing their dividend payouts for decades can be hazardous to your net worth. Many financial companies which were paying an increasing dividend each year halted their payouts in 2008 when the financial crisis hit. Companies like Bank of America and Citicorp not only lost the bulk of their value, but they also essentially eliminated their dividend payouts. Individual stocks, no matter how safe they might appear, can have a dramatic impact on your portfolio. Most people are better off investing in index funds.

Mr. Wonderful to the rescue?
With the popularity of dividend investing, there have been a growing number of dividend-based funds popping up. The most recent such fund is from Kevin O’Leary, aka Mr. Wonderful, of Shark Tank fame, O’Shares FTSE U.S. Quality Dividend ETF (ticker symbol: OUSA). ETFs are Exchange Traded Funds, similar to mutual funds, but they trade like stocks throughout the day, unlike mutual funds which are only priced once at the end of the day.

The 61-year old, Canadian-born, O’Leary’s O’Shares fund just starting trading this week on Tuesday, it invests in large- and mid-cap U.S. stocks that have low volatility, high dividend yields and are screened for high-quality balance sheets. This new fund, which of course has no historic track record; is comprised of 142 stocks; the five largest holdings are household names and some of the largest companies in the S&P 500, including Johnson & Johnson, Exxon Mobil, Apple, AT&T, and Microsoft. Leary’s goal for the fund is reasonable diversification; many of the 50 dividend-focused ETFs are market-cap weighted; as a company gets larger, it becomes a larger portion of the fund which could minimize its diversification. Some of these market-cap weighted funds become so focused that their top five holdings account for more than half of their total value; not very diversified.

The fund charges an annual management fee of 0.48%, which is on par with the 0.44% industry average for managed funds. Many index funds charge far less. A management fee of 0.48% means that you will pay $48 to the fund for every $10,000 under management. While that might not seem like much, index funds tend to charge 0.10% of less; that’s $10 to the fund for every $10,000 under management; the difference can really add up.

There are other dividend focused options
O’Shares is new and has no history, but it seems like an interesting option which you might want to put on your radar for future consideration. There are alternatives; one of which is a mutual fund, Schwab’s U.S Dividend Equity ETF (ticker symbol: SCHD). The fund’s strategic goals aim for growing dividend income, utilizing high-quality companies with strong fundamentals. Index is designed to measure performance of high-dividend yielding domestic companies that have a record of consistently paying dividends; seeking out companies which have been paying dividends for at least ten years and have been increasing their dividend for at least five years. Like O’Leary’s fund, the fund seeks to maintain diversification by limiting the size of any position to 4.5% of the fund’s total size. The five largest holdings are also household names: Proctor & Gamble, Johnson & Johnson, Pfizer, Verizon, and Microsoft. The rest of the top ten are also well-known companies: Exxon Mobil, Chevron, Coca-Cola, IBM, and Home Depot. The fund is currently paying out a healthy 2.9%; roughly 50% more than the S&P 500 index fund pays out. The fund has been around for just under four years, and like most funds, it has underperformed the S&P 500 index, but it has continually paid out a higher dividend payment that the S&P 500 index has.

We’re #2!
If a dividend payout is important to you, you might want to do further research into these two dividends paying funds and others. The Schwab fund is ranks #2 on U.S. News & World Report’s list of Best Fit Income Funds; they evaluated 95 Income Funds ETFs and 39 make their Best Fit list, the Schwab fund was #2 on their list. By the way, if you are interested, the #1 rated fund, the WisdomTree Total Dividend fund, is also a fine option.

Regardless, again, since most managed funds under-perform their associated indices, you just might be better off staying in the index fund and the bond fund and periodically performing an asset allocation adjustment by withdrawing cash as needed from the over performing funds. While bonds aren’t paying much now, eventually interest rates will rise, bonds will once again be a reasonable option.

Whether to focus your portfolio on dividend paying stocks in place of a portion or all of your stock index allocation or in place of your bond fund allocation is a personal decision; an index based portfolio is probably the best option of for most people, but we are not financial advisors, we are not making personal recommendations, we are just presenting you with options; consult your financial advisor for their input.

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