Comparisons among equity income mutual funds are tough because of differing ideas about the makeup of these funds. Some mutual fund companies limit equity income portfolios exclusively to high-quality, dividend-paying stocks. Other funds include bonds, especially convertible bonds. Thomson Reuters Lipper, a financial consulting firm, defines equity income funds as those that have at least 65 percent of their investments in dividend-paying equity securities, but this is not an enforced rule.
Mutual funds must disclose returns for various periods, including year to date, one year, three years, five years and longer, if available. Grabbing the mutual fund with the highest return might not make sense for several reasons. First, previous performance doesn't necessarily predict future results. Second, it’s important to know whether the fund manager who generated winning returns is still on the job. Third, it’s good to know how a fund performed compared to an unmanaged equity income index, such as ones from Wisdom Tree or Russell. If a managed fund doesn't consistently beat an unmanaged index, you might ask what value the fund manager adds.
Risk is measured by the volatility of an investment. The price of a highly volatile mutual fund jumps around more than average. Some mutual funds disclose several risk measurements, including beta, R-squared, Sharpe ratio and standard deviation. You might also find this information in the fund’s prospectus and on online fund screeners. You would expect an equity income fund to have a lower than average risk, because high dividends stabilize stock prices. The Sharpe ratio is very revealing, because it tells you how much return you get per unit of risk. Comparing funds on this basis helps you figure whether a fund’s good returns were due to expert stock picking or crazy risk taking.
Equity index funds should not cost as much as high-powered growth-stock funds. Because their focus is on steady income, equity-income fund managers normally seek big, stable companies with reliable dividend payouts. Typically, mutual fund companies reserve their highest expense ratios for fund managers who uncover obscure stocks that score big capital gains. You might want to eliminate equity income funds with expense ratios greater than 1 percent. For example, as of October 2013, the popular Fidelity Equity Income Fund charges 0.68 percent, and the Vanguard Equity Income Fund charges a scant 0.30 percent.
The easiest way to compare equity index funds, and for that matter, all types of mutual funds, is to use an online fund screener. Free ones are available from the "Wall Street Journal," Morningstar and many other sources. After picking the fund category, select and sort results based on the criteria you enter. For example, you might select low-expense equity income mutual funds sorted in descending order of three-year total returns. Read and understand the prospectus before investing money.
- Thomson Reuters Lipper: U.S. Open-End, Closed-End, and Variable Annuity Fund Classification Descriptions
- ETF Database: WisdomTree Equity Income Index ETF List
- Morningstar: Sharpe Ratio
- Fidelity Investments: Fidelity Equity-Income Fund
- The Vanguard Group: Vanguard Equity Income Fund Investor Shares
- The Wall Street Journal: Mutual Fund Screener
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