Equity-income funds may be the best investing strategy

BY WARREN BOROSON

BOROSON ON MONEY

There are all sorts of sensible ways to invest in the stock market.

A fellow I know has all of his money in Berkshire Hathaway, Warren Buffett’s firm. Another acquaintance has all of his money in one Mutual Series fund – the Mutual Series funds, which buy deep-value stocks, being inveterate winners.

Having a balanced fund as the core of your portfolio also makes sense. Vanguard Balanced Index, Dodge & Cox Balanced, or T. Rowe Price Balanced are good choices. I own shares of the Dodge & Cox fund, which has done the best of the three over 10 years.

Then there are lifecycle funds and target retirement funds, those blessed investments that give you a nicely diversified portfolio in just one fund. The target retirement funds deliver the extra benefit of getting progressively more conservative – investing more in bonds rather than stocks – as you approach retirement.

Another splendid strategy may be the best of all: investing in an equity-income fund. A fund that buys high-dividend-paying stocks from blue-chip companies.

Benefits:

Their stock prices are unlikely to take a big hit – so long as the dividend remains intact. If a stock yields 5% and it loses 10% of its value, the yield rises to 5.5% -- making the stock more desirable.
When you reach my advanced age, you don’t have to sell your holdings and buy securities that produce more income – and pay taxes on your enormous gains. You can just hold onto your high-yielding stock fund.

Some important points:

You want a true equity-income fund, not a fraud. Right now, the Standard & Poor’s 500 Stock Index is yielding 1.7%. How can a self-styled equity-income fund, like Fidelity Equity-Income, be yielding 1.6%? And what about USAA Income Stock, yielding 1.0%?
An alternative fund is one that targets high-yielding stocks that have regularly raised their dividends. This is a sign that the company is in good shape – and that the managers adhere to a provide-generous-dividends philosophy. Vanguard Dividend Appreciation (yielding 1.9%, five stars from Morningstar) is a possible choice.
Don’t forget Murphy’s Law. “Whatever can go wrong will go wrong.” Equity-income funds in general got taken out and shot a few years ago when financial stocks got taken out and shot. Equity-income funds always have a big exposure to high-yielding financial stocks. Lesson: Don’t keep all of your money in equity-income funds.

You could, of course, buy individual high-yielding stocks. But then you would have to track them (even good companies can turn sour), make sure that your stocks are in different industries, and have a big job at tax time – assuming you own at least 15 or 20 different stocks. Besides which, maybe you’ll be blessed with a fund manager who quickly dumps high-paying stocks in any industry that gets into serious trouble.

Then again, you might buy exchange traded funds that mindlessly buy high-yielding stocks. But I prefer to have a human intelligence watching out for my interests.

Naturally, you will avoid equity-income funds with loads — no matter how good they are. Example: Columbia Dividend Income, with a 5.75% sale charge, is yielding 2.1% and gets four stars from Morningstar.

Okay, now let’s look at some classy, no-load, true equity-income funds with reassuring Morningstar ratings.

Vanguard Equity-Income yields 2.6%, gets four stars. Morningstar: “It’s a fine holding.” Lost 30.9% in 2008.

Tweedy, Browne Worldwide High Dividend yields 2.1% and gets five stars. Only 43% in U.S. stocks, so it should diversify your portfolio. Morningstar: “This looks like a very good option for conservative equity exposure.” Lost 29.35% in 2008.

American Century Equity Income yields 2.9% and gets five stars. “Long-term investors who want a cautious approach to stocks should check this option out.” Lost 20% in 2008.

Don’t be shocked by those losses in 2008. The stock market itself lost over 38% that year – but I’m not surprised that you repressed the memory.

A fund I myself should have bought when it came out recently: Fairholme Focused Income, yielding 3.2%. It hasn’t been rated yet (Morningstar wants a fund to have a three-year record), but it’s been doing fabulously. In fact, I’ve decided to buy some shares right after I submit this article.

Warren Boroson will give a talk on the fundamentals of investing on Thursday, 10 to 11:30 A.M., at the Central Unitarian Church in Paramus under the auspices of the Institute for New Dimensions. To register, call 201-291-6163 or e-mail This e-mail address is being protected from spambots. You need JavaScript enabled to view it .