These noteworthy funds show investors the money.
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By Esther Pak | 01-28-11 | 06:00 AM | Email Article

Dividends seem to be on the forefront of many investors' minds today, as yield-starved fixed-income investors seek an alternative source of payouts. But dividend investing is not as straightforward a topic as one might expect, and yield figures can be misleading. This article on faux income and this one on understanding the yield figure in the proper context touch on many of the potential pitfalls for yield-reachers. And this article discusses why it's important to mind the volatility level of dividend-paying stocks before using them to supplant bonds.

Esther Pak is an assistant site editor of Morningstar.com.

For retired investors who are looking to dividend-paying stocks for a component of their portfolios, it's essential to focus on those funds with decent yields that have also maintained a careful balance of risk and reward.

Using the  Premium Fund Screener, we homed in on domestic-equity-income funds that fit the bill. We started by screening the domestic-equity universe for no-load offerings whose trailing 12-month yields were higher than that of the S&P 500 Index. And while investors should always be mindful of fees, costs are an especially crucial consideration for investors seeking income since fees can easily hack away at a fund's yield. To maximize net income, we sought fees lower than 1%. We also restricted bond and "other" (mainly convertibles and preferreds) exposure to less than 5% of the portfolio by filtering out any funds whose bond holdings had a significant effect on the funds' high-yield figures.

Additionally, we layered on a screen for funds Morningstar Ratings of 3 stars or higher as well as managers whose tenures extend beyond five years. And to further streamline our results, we called up distinct portfolios of funds that were open to new investments of $3,000 or less. The screener yielded more than a dozen funds, three of which we highlight below. Premium members can  click here to replicate this screen.

 Vanguard Dividend Growth 
Expenses: 0.38% | Yield: 1.90%
Manager Donald Kilbride sticks to a consistent, low-risk strategy that focuses on wide-moat firms with low valuations and enough cash flow for sustainable dividend growth. He seeks companies that prioritize dividend growth but not at the cost of increased risk or compromised quality. For example, he sold off  J.P. Morgan Chase  because he thought that the firm, and other banks, would be more tightfisted with capital in the future because of heightened regulations in the banking sector. Over the long term, this fund's returns have beaten the large-blend category and its benchmark Mergent Dividend Achievers Select Index. Coupled with its ultralow expenses, this no-frills Analyst Pick makes for a compelling core option for dividend investors.

 T. Rowe Price Equity Income 
Expenses: 0.72% | Yield: 1.86%
This fund's manager has experience on his side; Brian Rogers has helmed this fund since its inception 25 years ago. A true value investor, Rogers and his team of analysts look for companies trading cheaply relative to their historic price multiples while being mindful of a firm's ability to pay income. Rogers keeps his eyes peeled for fallen stocks that are temporarily and unduly suffering from negative market sentiment. Due to Rogers' skill in capturing opportunities during market uncertainty and preference for high-quality blue-chip companies that deliver strong dividend yields, the fund has delivered excellent long-term returns with good downside protection.

 Bridgeway Large-Cap Value 
Expenses: 0.84% | Yield: 1.71%
Bridgeway Funds' founder and lead manager John Montgomery uses quantitative models to uncover inexpensive companies with future growth potential. While some funds in Bridgeway's lineup have struggled during the past few years, this fund has managed to beat two thirds of its category peers during those same periods and lands in the top quintile since its inception. In addition to delivering strong long-term returns and a solid payout, management makes it a priority to keep both expenses and taxable distributions at a minimum. Moreover, Morningstar analyst Greg Carlson noted that a recent visit to Bridgeway's offices highlighted its shareholder-friendly culture and reinforced Morningstar's fund analyst team's confidence in Bridgeway's investment staff. All in all, this fund is worthy core dividend-focused holding.

Data as of Jan. 27, 2010.

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Esther Pak does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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