Dividend-paying stocks have a long and storied history of helping people build long-term wealth. However, not everyone is inclined to pick individual dividend stocks. You might find it easier to start with dividend-paying mutual funds and ETFs. Investors today have plenty of choices, and many with very low fees that let you retain most of your gains. 

Because there is no one-size-fits-all in investing, we're here to help you find the right dividend mutual fund to match your goals. In this article, we will define and break down the different kinds of dividend funds, so you can make sense of the choices. We will also feature several top dividend funds you may want to consider. 

Hand drawing line with dividends written on it.

Image source: Getty Images.

What is a dividend fund? 

In short, it's a mutual fund or ETF (exchange traded fund, which is a lot like a mutual fund, except it trades on a stock exchange) that primarily invests in stocks that pay dividends. Since different companies pay dividends at different times, the fund collects dividends over a period, such as quarterly or monthly, and then sends a single payout to investors. 

There are many types of dividend funds. Some examples:

  • High-yield dividend funds
  • Dividend growth funds
  • Monthly dividend funds (meaning it sends investors a dividend check each month)
  • Sector-specific dividend funds (such as real estate, utilities, or healthcare)
  • Dividend index funds
  • Actively managed dividend funds

These are just some examples of the kinds of mutual funds and ETFs you may find with dividend-focused investments. 

Dividend ETFs and dividend mutual funds

You may have arrived here by searching for "dividend mutual funds," but there's a good chance an ETF could be the right fit, too. In general, they're similar ways for investors to accomplish the same thing: invest in a large basket of stocks without having to pick out individual investments.

Without belaboring the details, the biggest difference you'll notice is that ETFs trade like stocks on stock exchanges while mutual funds are bought and sold directly from the mutual fund manager. Additionally, mutual funds often have high minimum investment amounts while ETFs trade for the price of a single share. Deciding between ETFs and mutual funds is dependent on your needs and situation as much as anything else.  

Leveraged dividend ETFs

You may also encounter leveraged dividend ETFs. Leveraged ETFs, which aim to give investors double (or sometimes more) the returns of their non-leveraged counterparts,  can look very attractive, but there's a catch. The use of leverage can backfire if things don't go perfectly. It can amplify returns when the market is going well, but leveraged ETFs also amplify losses when the market falls. Moreover, they're typically built to "reset" over short periods of time, which can be daily, monthly, or quarterly, based on the debt or other instrument being used to create the leverage. 

Simply put, these aren't ideal "buy it and forget it" investments that are typical for dividend investing, and there may be far more risk of permanent losses than you realize. 

Dividend reinvestment ETFs

A dividend reinvestment plan, or DRIP, is a way to automatically reinvest dividends into new shares of a particular investment. However, this isn't something that every fund offers, and you'll need to confirm in a fund's prospectus -- both ETFs or mutual funds you are considering -- how it treats dividends. 

The good news is, since ETFs trade like individual stocks, you can set up automatic dividend reinvestment in your brokerage account. Nearly all online discount brokers offer this feature free of charge. If you use dividend reinvesting in your account, your brokerage will take your dividends and reinvest them in new ETF shares automatically. In most cases, you should be able to set up automatic dividend reinvestment in mutual funds as well. Just check with your broker, or financial advisor if you invest in mutual funds through an advisor. 

Five top dividend funds to invest in

Fund Name Dividend yield* What investments are in the fund? Who's it for?
Health Care Select SPDR ETF (NYSEMKT:XLV) 1.52% Healthcare industry components of the S&P 500 index.   Investors looking to participate in the growth in healthcare spending in the decades ahead, which should continue to drive dividend growth for this ETF. 
iShares Core Dividend Growth ETF (NYSEMKT:DGRO) 2.22% Companies in the Morningstar U.S. Dividend Growth Index. Investors looking for a mix of dividend growth and capital appreciation.
ProShares S&P 500 Aristocrats ETF (NYSEMKT:NOBL) 1.91% Companies on the S&P Dow Jones Indexes Dividend Aristocrats list.  Investors looking to own stocks with long track records of dividend growth. 
Vanguard High Dividend Yield Index Fund ETF Shares (NYSEMKT:VYM) 3.05% Companies in the FTSE High Dividend Yield Index. Investors looking for income or high-yield dividends to reinvest. 
Vanguard Real Estate Index Fund ETF Shares (NYSEMKT:VNQ) 3.41% Real Estate Investment Trusts -- REITs -- featured in the MSCI US Investable Market Real Estate 25/50 Index. Investors looking to invest in real estate, either for income or for portfolio diversification. 

*As of January 3, 2020.

Let's take a closer look at each of these five dividend funds. 

Health Care Select SPDR ETF

This ETF may not seem like a dividend-focused fund at first glance, particularly with a dividend yield that's rarely ever gotten above 2% in the two decades this fund has existed. But what it lacks in yield, it makes up for in dividend growth. From 2010 to 2020, the Health Care Select SPDR dividend increased a remarkable 291%, or nearly double the 157% dividend increase for the S&P 500 as a whole.

This fund holds 61 different healthcare companies (as of January 3, 2020) in the S&P 500, across pharmaceuticals, medical devices, biotech, and healthcare providers. Looking at the future, investors should be able to expect the companies held in this fund to continue growing their dividend payouts, as two big trends drive increased global healthcare spending: the aging of the Baby Boomer generation in developed countries, and the explosive growth of the global middle class in developing nations around the world.  

iShares Core Dividend Growth ETF

Investors looking for a more diversified dividend growth fund may want to consider the iShares Core Dividend Growth ETF, which tracks a broad index of companies with a track record of high dividend growth. This dividend fund holds 478 different stocks across every major industry (as of the start of 2020).

It hasn't been around nearly as long as the Health Care Select SPDR, but its recent track record has proven quite solid. From 2016 to 2019, it generated 92.4% in total returns -- dividends plus capital appreciation -- outperforming the S&P 500's 86.2% over the same period. The dividend payout was increased a massive 49% over that period, helping juice both the income and the returns investors will return over the long term. 

History favors the iShares Core Dividend Growth ETF as a long-term investment, too. Historically, high-quality dividend stocks such as those held in this fund have outperformed the stock market over the long term. 

ProShares S&P 500 Aristocrats ETF

The ProShares S&P 500 Aristocrats ETF is an excellent way to invest in companies with very long track records of dividend growth. This fund invests in the companies on the S&P Dow Jones Indices Dividend Aristocrats, which included 57 stocks (as of the end of 2019) from the S&P 500 which had increased their regular dividend every year for at least 25 consecutive years. 

In short, Dividend Aristocrats are the tried-and-true when it comes to long-term dividend growth. From 2015 to 2019, the Aristocrats ETF increased its dividend payout 122%, and it has increased the dividend payment 228% since inception in 2013. Despite its relatively low yield, long-term investors looking to generate solid total returns and build a portfolio of future income should consider this dividend fund. 

Vanguard High Dividend Yield Index Fund 

If you're looking for higher yield, the Vanguard High Dividend Yield Index Fund (NASDAQMUTFUND:VHDYX) should be on your radar. This fund holds 404 different companies (as of November 30, 2019) across 10 major industries, with a median market cap of nearly $111 billion. While it is a relatively diverse portfolio, it's dominated by some of the biggest, most profitable companies on earth, with the 10 largest holdings making up more than 26% of total net assets. 

This fund has also proven an impressive dividend grower over the past decade, with payouts up 240%; however, that growth was juiced by the recovery of dividends from a number of industries which had cut their payouts during the global financial crisis. In other words, investors may not want to set their expectations for this rate of growth going forward. 

But with that said, anyone who's looking for a higher yield -- but is willing to hold their investment across the market's ups and downs -- should consider this fund. It is also available as an ETF, Vanguard High Dividend Yield ETF (NYSEMKT:VYM) with a $3,000 minimum investment requirement. 

Vanguard Real Estate Index Fund

Real estate has a long track record as a reliable income investment. And while owning individual properties is out of reach for most people, publicly traded REITs make it much easier for the average investor to participate in this market. The Vanguard Real Estate ETF -- which is also available as a mutual fund -- goes one step further, giving people access to a fund that holds 185 high-quality REITs (as of November 30, 2019). 

Why real estate? In short, because it has proven, over time, to be a reliable source of income as well as a somewhat "safer" asset class. In general, REITs aren't as volatile as other stocks, since most property types hold their value and continue to generate income across economic conditions. This means that REIT share prices don't fall as much as other stocks when the market falls, and tend to recover much more quickly. 

Put it together, and REITs can make an excellent way to help offset your exposure to other stocks, while also owning an investment class with a long history of high dividend yield and modest dividend growth. If that's what you are looking for, the Vanguard Real Estate Index Fund might be ideal. It's also available as a mutual fund, Vanguard Real Estate Index Fund Admiral Shares (NASDAQMUTFUND:VGSLX), with a $3,000 minimum investment requirement.

Dividend funds can help you reach your financial goals

Whether you're in the early stages of building your wealth and have many decades still ahead, are already retired and looking for a way to generate income, or somewhere in between, dividend mutual funds and dividend ETFs can play a role in helping you achieve your financial goals. 

The key is to make sure you know what your goals are, pick dividend funds that are built to help you reach them, and then invest with a long-term mentality. Whether it's income for today or wealth for tomorrow, focus on your goals and invest to hold for the long term.