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How Does Your Passive Dividend Fund Avoid Risky Stocks?

Successful dividend-focused funds find harmony between risk and yield.

Actively managed equity-income funds tout their ability to put together a portfolio of stocks that offer above-market dividend yield while avoiding riskier stocks. Chasing yield can be dangerous because the highest-yielding names are more likely to have weak or deteriorating fundamentals than lower-yielding stocks, which could lead to dividend cuts. More importantly, the market identifies firms with declining fundamentals, and these stocks' prices reflect their slumping prospects ahead of them reducing or eliminating their dividend payments.

Dividend index funds use a handful of approaches to mitigate the risk of holding stocks with deteriorating fundamentals. These approaches can be roughly sorted into four categories:

1. Profitability Screens

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About Author

Adam McCullough, CFA  Adam McCullough, CFA, is an Analyst on Morningstar’s Manager Research Team, covering passive strategies.

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