Which Types of Mutual Funds Pay the Highest Dividends?

For many people, the reliability of dividend or interest income is one of the primary benefits of investing. Like individual stocks and bonds, mutual funds can be a great source of dividend income. However, not all mutual funds pay dividends, so if generating regular dividend income is important to you, learn which types of funds pay the highest dividends.

Key Takeaways

• Mutual funds pool money from multiple investors to invest in a diversified portfolio of assets.
• Higher-paying mutual funds often invest in dividend stocks, bond funds, REITs, or utility funds, which focus on generating consistent income for investors.
• Funds that must distribute a significant portion of their taxable income, such as REITs, are also required by law to pay high dividends.
• Dividend stock funds focus on stable companies with a track record of paying dividends, while bond funds invest in interest-bearing securities, including high-yield “junk” bonds.
• Risks associated with high-dividend mutual funds include interest rate sensitivity where the value of the mutual fund goes down when rates go up.

Understanding Mutual Funds

Let’s very briefly touch on mutual funds. A mutual fund is a type of investment vehicle that pools money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other securities. Managed by professional fund managers, mutual funds aim to provide investors with broad market exposure.

Compared to exchange-traded funds (ETFs), mutual funds typically trade only once per day at the fund’s net asset value. ETFs generally trade throughout the day (like a stock). Mutual funds can be actively managed or passively managed.

Mutual funds often have higher expense ratios due to active management fees, whereas ETFs generally have lower costs because many track an index. Mutual funds may also have minimum investment requirements, unlike many ETFs (beyond just the cost of one share of that ETF).

General Characteristics of Higher Paying Mutual Funds

Before touching on exact types of funds, let’s cover some general conditions that usually exist for mutual funds to pay higher dividends or distributions. These characteristics may not reside in every fund, but generally speaking, funds will pay higher dividends if they have:

• Regulatory Requirements: Certain types of funds pay high dividends because they have to. Certain funds must distribute most of their taxable income to shareholders as part of their tax-advantaged status. Without these required distributions, certain funds may be at risk of facing corporate taxes at the entity level.
• Stable and Predictable Cash Flows: Funds that invest in businesses with steady and reliable cash flows tend to pay higher dividends. Funds that focus on companies that provide essential services tend to have more stable cash amounts coming to the company, meaning they can payout greater amounts.
• Income-Oriented Investment Strategies: Similarly to the second bullet above, certain mutual funds are specifically designed to maximize income rather than capital appreciation. We’ll touch on this more in the last section, but you can generate wealth through dividends, by the value of your investment increasing via capital appreciation, or both.
• Compensation for Higher Risk: All else being equal, investments tend to reward investors by taking on risk with the promise of higher payouts. These may not always materialize, but investors do tend to look for additional or higher forms of compensation in exchange for carrying that extra risk.

Now, let’s look at specific types of mutual funds that tend to pay the highest dividends.

Dividend Stock Funds

For those who are primarily interested in generating regular dividend income but are willing to take on some risk for the chance at capital gains, dividend stock funds can be an excellent choice. These funds are focused on investing in stocks that have reliable track records of paying healthy dividends each year. Since paying dividends to shareholders is considered a sign of a company’s financial stability, many companies pride themselves on issuing increasing dividends each year.

Dividend funds are not focused on identifying the next Wall Street darling, unless it pays dividends, but all stock investments have the potential to increase or decrease in value based on market fluctuations and the performance of the issuing company. Though dividend funds are not focused on creating capital gains, the stock of a healthy company that pays significant dividends is likely to go up over time, potentially increasing the value of the fund.

Note

Understand that mutual funds that prioritize dividends may not grow in size. You’re more likely to get cash returned back to you as a dividend or distribution as opposed to its stock price going up.

Bond Funds

Unlike stock funds, distributions made by bond funds are the result of interest income generated by the bonds in the fund’s portfolio. The interest rate, or coupon rate, paid by a bond is influenced by many factors, including the credit rating of the issuing entity and national interest rates at the time of issuance. While the interest rates of bonds issued by very stable, creditworthy corporations and governments tend to mirror rates set by the Federal Reserve, less stable entities often offer bonds with higher rates because the risk they will default on their financial obligations due to insolvency is greater.

High-yield bond funds, therefore, invest in very low-rated bonds, called junk bonds, because they pay extremely high rates of interest to compensate investors for the increased risk of default by financially unstable issuing entities. Though the income from these types of funds can be substantial, it comes at considerable risk. Other less-risky bond funds make more moderate distributions but carry a much lower risk of loss.

Real Estate Investment Trust (REIT) Funds

Another potential mutual fund is a REIT. REIT funds invest in publicly traded real estate investment trusts, which are required by law to distribute at least 90% of their taxable income as dividends. These funds can hold a variety of real estate assets like commercial properties, residential housing, healthcare facilities, or industrial warehouses. Because of their income-focused structure, REIT funds often offer some of the highest yields among mutual funds.

However, REIT funds are sensitive to interest rate movements, as rising rates increase borrowing costs and can reduce demand for real estate. Additionally, economic downturns can negatively impact occupancy rates and rental income. This has a direct impact on cashflow which then effects dividend payouts.

Utility Funds

Utility funds invest in stocks of companies that provide essential services such as electricity, water, and natural gas. Because utilities can be considered an “essential”, these companies tend to have more stable revenues. These types of companies may be more likely to have more steady demand regardless of economic conditions.

Because of this stability, utilities can pay higher dividends. Additionally, utility stocks are considered defensive investments, meaning they may even perform better during economic downturns when other “non-essential stocks” might struggle. Also, utility companies are uniquely positioned to more aggressively pass along costs to customers (as opposed to more elastic industries).

A Note on Dividends vs. Capital Appreciation

As an investor, you can generate wealth through mutual funds that pay high dividends. You can then reinvest those dividends and take advantage of compounding.

On the other hand, wealth creation can also come through capital appreciation. Assets can increase in value over time, such as growth stocks, real estate, or equity funds targeting high-growth industries. Unlike dividend investing, where income is received regularly, capital appreciation strategies rely on buying low and selling high.

There’s no single best strategy, and each investor’s personal strategy may be different from others. Keep in mind that, if you prioritize dividends or cashflow, you may be sacrificing capital appreciation. This may be fine for your personal strategy, but if your goal is to maximize wealth generation, there may be more balanced strategies that generate more wealth in the long run.

Which Types of Mutual Funds Pay the Highest Dividends?

Mutual funds that pay high dividends focus on investments that generate consistent income, such as dividend-paying stocks, high-yield bonds, real estate investment trusts (REITs) often pay higher dividends (or higher distributions).

Why Do Some Mutual Funds Pay Higher Dividends Than Others?

Some mutual funds pay higher dividends due to the nature of their underlying investments. Funds that focus on certain types of investments may generate higher income because these securities are designed to distribute earnings to investors. Additionally, some companies, especially those in safer or more mature industries, prioritize returning cash to shareholders instead of reinvesting profits into growth.

What Are the Risks of Investing in High-Dividend Mutual Funds?

While high-dividend mutual funds provide regular income, they come with risks such as interest rate sensitivity, sector concentration, and dividend sustainability. Many of these types of funds may decline in value when interest rates rise as their dividends/distributions become less attractive to new fixed-income investments established at a higher rate.

How Often Do High-Dividend Mutual Funds Pay Distributions?

Distributions depend entirely on the fund itself; many may pay out quarterly, though some funds may pay out monthly or annually.

The Bottom Line

Certain types of mutual funds like dividend stock funds, high-yield bond funds, REITs, or utility funds may have higher dividends/distributions. Though these funds tend to be at greater risk for increasing interest rates, they can also make for an attractive investment option for retirees and income-focused investors.