In our last thrilling episode (Too Much Income Can Be Hazardous to Your Financial Health – Part I) we talked about the risks of holding bond (fixed income security) funds. Simply put, the current income is nice but neither the income, not the principal increase over time, absent a good fund manger. So what’s an investor to do?

 

Find a good conservative mutual fund which invests in dividend paying stocks. Why? Because dividends paid by good companies tend to increase over time. Take Bank of America, for example. (I’m using a stock rather than a mutual fund for this illustration because it avoids having to talk about purchases, sales and capital gains distributions.)  In 1997, Bank America paid a $.70 per share dividend. If you bought the stock near its high for that year, you paid $40 per share. Today, B of A pays a $2.24 dividend and its stock sells for around $50.   Notice, the dividend has increased 3x in the past ten years. The price appreciation hasn’t been nearly as exciting, but it has kept pace with inflation. 

 

There are a lot of stocks out there like Bank America, which increase their dividend every (or almost every) year. The investor who bought B of A stock in my example has an investment currently yielding 5.6% and I would expect the yield to continue increasing. You can find many mutual funds that invest in high quality, dividend growing stocks. Start by looking at Big Cap Value funds.  Many such funds have the word income or dividend in their name.

 

As I said on Monday, there are lots of good reasons to invest in bond funds, but if you have a time horizon of ten years or more, you’ll be better off investing in a high quality equity mutual fund. You’ll end up with more principal and income.