To Pick the Right Dividend Fund, Learn How They Work

Know Your Fund

Lastly, when evaluating a dividend-paying fund, take a close look at where those dividends come from. While dividends from stocks, bonds, REITs and the like are all taxed the same way, how much they contribute to an income fund can significantly affect the rest of your portfolio.

For instance, if you've invested in a balanced fund looking for income, but the income comes largely from the bonds in the fund's portfolio, you may be better off investing in a bond fund for income and an equity fund for growth. If you're dependent on the income produced by a fund and are looking for a core holding, don't choose one that has the bulk of its income generated by REITs. (You don't want a significant percentage of your portfolio in such a tiny sliver of the market.)

And if you're using dividends as a way of justifying getting back into equities, make sure you find an equity fund that's paying a dividend that's higher than the S&P 500 after expenses, and that the dividends are actually from stocks.

Because while investor sentiment has had a retro-conservative bent, the 3.5% S&P yields of yore have not yet become new again.

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