Business / Technology

Q: My question concerns what is the better source of dividends from a long-term investment viewpoint.

I am well-diversified in my total portfolio.

I am invested in Vanguard LifeStrategy Moderate Growth Fund and some fixed-income funds.

I also like blue-chip dividend-paying stocks.

I have some money invested in Vanguard Dividend Appreciation Index Fund and Vanguard Dividend Growth Fund (Managed).

A friend argues that I should seek dividends not by sector investing but by total-market index funds.

He points out that the yield on my two sector funds is about 2 percent — similar to the yield on the LifeStrategy Moderate Growth Fund.

He believes, from an investment perspective, the LifeStrategy Moderate Growth Fund is vastly superior to the two sector funds.

He acknowledges that the current tax code favors qualified dividends, but he insists that the use of the three total-market index funds in the LifeStrategy fund is a wiser investment strategy.

A: Your friend makes good points.

Here's the difference between these funds. Vanguard Dividend Appreciation Index fund and Vanguard Dividend Growth fund are 100 percent equity funds.

They have no fixed-income holdings.

They are, however, diversified across many sectors of the economy, so I would not call them "sector" funds.

The Vanguard LifeStrategy Moderate Growth Fund is a traditional balanced fund.

It has about 40 percent of its assets invested in fixed-income securities.

The equity portion is spread over three major total-market indexes.

The fixed-income portion is why its income yield is about 2.3 percent, while the yield on the dividend funds is about 2 percent.

Over the (very) long term, the expected return of the 100 percent equity funds should be somewhat higher than the return of the balanced fund.

The long term, however, is a lot longer than any of us can hold our breath.

In addition, the dividend income of the dividend funds is currently taxed at no more than 15 percent, while the tax rate on the balanced fund will be a mixture of 15 percent taxes on dividends and the full income-tax rate on interest.

There is no doubt that you will enjoy far broader diversification in the LifeStrategy Moderate Growth Fund; it will also be less volatile than the dividend-oriented funds, so you'll sleep better.

Questions: scott@scottburns.com