Forget Bernanke...Buy These 4 Dividend Funds

Adem is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Nothing, and I mean nothing, has the ability to consume Wall Street quite like Ben Bernanke. After an upbeat U.S. jobs report, interest in the bearded Fed Chairman has reached a fever pitch.

Now, more than ever, Wall Street is telling us that they're sure the end of "QE-infinity" is coming soon. Some experts are even saying that Benanke's Fed may taper its bond buying program by summer's end.

I can't say when the bond buying will end, causing interest rates to rise, but at some point it will happen.

What's the real threat?

If you're a relatively passive investor, you may be wondering why all of this matters; or you may wonder which markets will get hit the hardest by the end of QE. The bond market is the most vulnerable, and here's why.

1). The bond market, which is the largest market in the world, has seen investors flood its doors since the great recession seeking safety. This has kept interest rates extremely low and, since interest rates and bond values move in opposite directions, bond prices could plummet with any interest rate increase.

2). The stock market has been artificially juiced by QE. Low bond yields have forced investors into stocks. But that "forcing" happened largely when the economy was struggling, QE won't end until the economy is ready, so stocks should be somewhat resilient.

So what should you do? With bonds tenuous at best and the stock market at all-time highs, now is the best time in years to invest in low cost dividend stock funds.

Dividends: The best way to beat Bernanke

Dividend stock funds make so much sense right now, it's silly. The market has run up too high, too fast, and "indexing" or buying ETF's offers some safety in diversification.

But the biggest reason you should buy these funds is because of Bernanke. If the Fed raises rates, and bond yields rise, dividend paying companies will need to increase their payouts as well. The only difference from bonds is that when stocks raise dividends--their prices go up!

One great dividend fund is the SPDR S&P Dividend ETF (NYSEMKT: SDY). If you're looking for safe, blue chip, dividend stocks this is your fund. This fund boasts General Dynamics, AT&T, and Pitney Bowes among its largest holdings but none of them consists of more than 3% of the portfolio. The 2.7% yield is enticing on its own merit, but the fund has also rallied about 30% this year. This fund is as much of a "blue chip" as the stocks in its portfolio; it has low fees, just 0.35%, and it holds a perfect five star rating from Morningstar. This is the safest bet on dividends going forward. 

I'm also very bullish on the Vanguard Dividend Appreciation ETF (NYSEMKT: VIG), but for a different reason than SDY. This fund gives you 2.2% yield but, as the name suggests, it consists of growth companies that have the potential to increase their dividend along with earnings. Gone from this fund are traditional dividend names in telecom, and banking. Rather, this fund's largest holdings include Pepsico, Coca-Cola, Wal-Mart, and ExxonMobil but none hold more than 5% of the funds resources.

Holding less than 5% of any one holding is essential to passively managed funds; after all you're giving up 10-bagger potential for the safety that diversification brings. You may not have to give up all that much, however; the fund is up over 25% this year. Vanguard funds have a reputation of having very low fees, and VIG is no exception, the fund has an expense ratio of just 0.10%.

Speaking of Vanguard, if you're looking for some international exposure in your dividend portfolio you should consider adding the Vanguard Emerging Markets ETF (NYSEMKT: VWO) to your holdings. This fund holds mostly mega-cap stocks in emerging economies like China, Korea, and Brazil. The largest holdings include China Mobile, Taiwan Semiconductor, and Samsung. The average P/E of the stocks in this portfolio is 11, and the dividend yield is over 4%. That yield may surprise you, but most international stocks pay higher yields than U.S. stocks, which is what makes this fund so attractive. Like all Vanguard funds expenses are low, a measly 0.18%. Unlike the other stocks mentioned, and due to international market woes, this fund is trading closer to its 52-week lows. I think that between the low valuation, high dividend yield, and international diversification possibilities, this fund should make up a small part of your broader dividend portfolio.

Preference for preferred stock?

Of course, I would be remiss if I ended this post without mentioning preferred stock. When talk began that QE may end soon, preferred stock funds took a dive. The reason is that "yield chasing" investors have dove head first into these funds, along with junk bond funds, but the two investments are vastly different.

Preferred stocks have shown some sensitivity to interest rate increases, but they're much safer than junk bonds. This investment vehicle exists somewhere between bonds and stocks, and is actually safer than common stock. These aren't bonds, they're shares of stock, but should a company go bankrupt these shareholders get paid first. These funds shouldn't be as sensitive to interest rates increases as bonds are, not by a long shot, so they're a better alternative.

I recommend iShares S&P U.S. Preferred Stock Index Fund (NYSEMKT: PFF), which pays a robust 5.85% dividend yield. Its price variance was less than 5%, so it's unlikely to see large capital gains or losses. The fund has low expenses,  an expense ratio of just 0.48%, and it holds $11 billion in resources largely in financials such as Citibank, and Barclays. In short, when it comes to preferred stocks, I'd say I prefer them over bonds. They're a nice addition to a dividend portfolio, and as long as you're dollar-cost-averaging into a fund, you shouldn't get burned when rates rise.

Safety meets growth

If you'd invested in this portfolio over the past year, you'd have earned outstanding yields and, in some cases, gains of 25%. The funny thing is, with the bright outlook for dividend stocks, these "safe" funds may offer even better growth going forward.

The best part is, you won't need to follow Bernanke's every move. You can rest assured knowing that, if rates rise, you're in a well diversified dividend fund. You can know that you're in the safest possible place to be, with wonderful absolute return potential.

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Adem Tahiri owns shares of the Vanguard Dividend Appreciation ETF fund. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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