High dividend fund DVY compared with S&P 500 fund SPY for 2006 - 2011.

During times of economic turmoil and unrest in the stock markets, many investors start asking themselves if they would be better off when they invest their savings in high dividend funds.

Dividends matter. The fund managers of the high dividend funds would like you to believe that their funds are your best option at this moment. Is that actually the case? Pay attention to the following.

Dividends for Dummies

According to the writer of the Index Investing for Dummies book, there is no extra benefit in investing in higher dividend funds compared to normal index funds. He advocates to split your capital over large and small stock funds and to forget about special dividend funds.

He argues that dividend stocks just do not show the growth as other stocks and therefore do not offer higher total returns on investment than the average.

Before our next blog post I will investigate this further and let you know my conclusions.

Rebalancing High Dividend Funds

If you wonder about investing in High Dividend funds or in Growth Funds, consider this. Since nobody can predict the future, a general accepted way to manage different types of assets in your portfolio is to rebalance regularly. This would work in the following way.

You put 50% of your money that you have earmarked for the stock market in high dividend index funds and 50% in growth index funds. Every year, you rebalance. You sell and buy the funds to get to the situation again that each hold 50% of your total invested amount.

In this way you do not attempt to time the market. You just move funds from the one asset that has gained more than the other.

28% Gains for the SPY, 20% for the DVY

What do you think? Will High Dividend Funds outperform an index like the S&P 500 during bear markets, during bull markets or all the time?

During the bull market from December 2003 to March 2008, the S&P 500 index fund SPY gave a total return of 28%. This includes the dividends.
For the same period, the total return of the DVY, Dow Jones Select Dividend Index Fund was only 20%. Also this number includes the dividends.
Can we conclude from this that the average index outperforms the high dividend funds during bull markets?

No, it is not that easy. It has to do with how much the different funds lost in the bear market before and what the reason for that bear market was.

I will reveal the conclusions from our research in the next blog post.

Dividends versus Fund Price

In general I stay away from just buying normal or high-dividend funds when the long-term trend is down, since I expect that the extra dividend does not cover the loss in stock price during that period.

However, I do support an asset allocation where you put a minority of your savings in a high dividend fund to provide you with a stable flow of returns.

You can rebalance then on an annual basis to keep roughly the same percentage of your savings in these high dividend funds. But… just look at the dividend income you get from this. Do not look at the fluctuations in the price of the funds you own.

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Thus, high dividend funds can be a good option... depending on if you just look at the dividends or also at the price of the fund.