Pension funds pay dividends

Ten important questions about dividend funds

Lana Iliev, November 5th, 2020

1 | What are dividend funds?

A dividend fund is a regular equity fund whose management follows a dividend strategy, such as the "DWS TopDividende". A dividend fund only contains blocks of shares from companies that regularly pay out part of their profits to their shareholders in the form of dividend distributions.

2 | What types of dividend funds are there?

As with mutual funds in general, dividend funds come in both distributing and accumulating forms. With a distributing dividend fund, the investor regularly receives his share of the dividend payments. In the case of an accumulating dividend fund, however, the profits are not paid out, but are reinvested immediately. In the case of accumulation funds, the compound interest effect is automatically used, while the investor receives a payment in the case of distributing funds.

3 | When do dividend funds make sense?

Dividend funds make sense especially for medium or long-term investments. Long-term growth in returns can be achieved through immediate reinvestments, especially in accumulating dividend funds.

4 | What are the advantages of dividend funds?

Compared to traditional equity funds, dividend funds offer a clear advantage: the regularly paid dividends can cushion any price fluctuations in individual dividend stocks.

A dividend fund also offers investors a number of advantages compared to buying individual shares (“stock picking”) while pursuing a dividend strategy individually. First of all, like funds in general, dividend funds allow investments to be diversified and, as a result, a certain spread of risk.

In addition, the investor can rely on the expertise of the fund manager and does not have to inform himself about the stock corporations and their dividend distributions. Still, this doesn't mean that the investor can sit back and let the fund work for them. The regular review of the fund's performance is absolutely necessary, only the comprehensive examination of individual dividend stocks is relieved of the investor.

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5 | What should be considered when buying?

There is a wide range of dividend funds to choose from - it is not at all easy for investors to make a meaningful decision. The following table outlines the five important characteristics of a dividend fund:

Characteristics of dividend funds
(avg.) dividend yieldAs with the dividend strategy for individual stocks, a dividend yield can also be calculated for a fund. The average value of the individual stocks in the fund is determined. The dividend yield is the key figure for a dividend fund. Still, she shouldn't be the only one paying attention.
Fund costsLike classic funds, dividend funds also have fixed costs to finance the administration of the fund. In order to make a decision in favor of a dividend fund, the amount of these costs should be considered and compared.
Fund managementThe performance of a dividend fund is significantly influenced by the quality of fund management - the fund's success stands and falls with it. Investors should ask themselves the following questions: What strategy is being pursued? Which dividend stocks are selected and included in the fund? How has the dividend fund developed in recent years?
Long-term development and volatilityBefore deciding on a specific dividend fund, the investor should take a close look at the fund's long-term development. Comparative indices and benchmarks should be consulted and viewed retrospectively over a period of five to ten years.
Volatility is particularly suitable for getting an exact picture. As a mathematical variable, it summarizes the fluctuation range of investment fund shares and thus provides information on how risky an investment is. If a dividend fund has low volatility, it is considered to be low-risk.
However, it should be noted that the positive development of a dividend fund in the past is no guarantee for its success in the future.
Investment strategyIn addition, information about the investment strategy of the dividend fund should be obtained in advance. The investor should ask himself to what extent the strategy of the fund fits his own objectives and his personal investment behavior. Although dividend funds only accept stocks from stock corporations that are as stable as possible and with high dividend distributions, the strategy of the fund and the selection of individual stocks can still be more cautious or aggressive.

6 | Classic dividend fund or dividend index?

In addition to the dividend fund, investors have the option of a dividend index. A dividend index is an ETF that has a passive dividend strategy. This enables the investor to save fund costs, as extensive fund management is no longer necessary.

At the same time, however, the index is riskier than the classic dividend fund. The reason for this is that only the dividend yield is taken into account. If the dividend distributions of a stock corporation develop differently than expected, for example due to internal company events, the dividend index will not take these into account. An active fund manager, on the other hand, can intervene at any time and possibly prevent any losses due to reduced dividends.

7 | How are dividend funds taxed?

Dividend funds are taxed like traditional investment funds and are subject to the withholding tax. The dividends and profits from price increases when the fund shares are sold are taxed at 25%. In addition, there is the solidarity surcharge (5.5%) and, if applicable, the church tax (8-9%). Detailed information on the taxation of investment funds can be found in the BERGFÜRST advice articles on the topics of funds and flat tax.

The taxation of investment income through the withholding tax is a controversial political issue. Some politicians are calling for the final withholding tax to be abolished and thus for taxation based on the personal tax rate.

8 | Why are dividends often compared to interest?

In the recent past, dividends have often been referred to as “the new interest”, as average dividend yields have been higher than short-term interest rates in recent years. This development is primarily due to the low market interest rates and the ECB's zero interest rate policy. However, this comparison lags, because dividends are not interest!

While interest rates, for example in the context of government bonds, are fixed, dividends are redefined annually by the shareholders' meeting and may not be paid out at all. Dividend funds remain equity funds and harbor the associated risks, even if they offer a bit more protection than traditional mutual funds. In addition, the positive development of dividend yields in the past is no guarantee of a similar development in the future.

9 | How safe are dividend funds?

Compared to traditional equity funds, dividend funds carry a lower risk. This is because the dividends that are regularly paid out and reinvested if necessary act as a kind of buffer and can cushion price fluctuations. Dividend funds can also be characterized as more secure compared to buying individual shares while pursuing the dividend strategy, as they offer a certain degree of risk diversification through the diversification of dividend stocks.

Nevertheless, investing in a dividend fund remains an equity business and thus also harbors the risks of such. The return is subject to unpredictable developments in stock corporations and price fluctuations, even if these can be cushioned to a certain extent by pursuing the dividend strategy.

In addition, the investment strategy proves to be extremely complex and the success of the fund depends on the performance of the fund management. The selection of possible dividend stocks is great, as are the variations in which they are put together in the funds. An experienced investor is required to maintain an overview here.

All in all, dividend funds are a little safer than classic equity funds, but nevertheless certain risks remain and investors are offered lower-risk investment alternatives.

10 | What alternative is there to dividend funds?

If the risks of dividend funds or equity investments in general seem too high for you, you might want to try real estate crowd investing. In contrast to dividends, which are set anew from year to year and can fluctuate considerably, a fixed interest rate is agreed with crowd investing, which is between 5.0% and 7.0% p.a. In addition, not only can fund costs be saved with crowd investing, acquisition costs or a paid deposit are also not necessary.

In contrast to shareholders in dividend funds, investors who rely on crowd investing do not have to rely on the skills of a fund manager. The investor is responsible for managing his investments. This is not a disadvantage, because the investments are made via a crowd investing platform that offers maximum transparency and simplicity. One of these platforms is BERGFÜRST, which specializes in investment projects in the real estate sector.

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