The past few months, I have been reintroduced to fairy tales as a father reading to his child. One story element that really captured my attention was that of a goose laying golden eggs. Imagine, what would life be like if you have something that offers a regular source of wealth without lifting a finger?
In the real world, this concept relates to a passive income.
Back in the 90s, I would hear the term “living on interest” from time to time – but this was an era when double digit interest rates are still available. As interest rates declined throughout the years (because of lower inflation), this concept is then transformed into investing in real estate and living from the rental income.
In today’s economy, buying properties is a tall hurdle and may force your wealth into being too concentrated. This is the time where dividend-paying funds show their appeal as a passive income source as you can invest smaller amounts while enjoying similar benefits.
Dividend Paying Funds: How Does It Work?
Pooling funds is the same concept used for mutual funds, Unit Investment Trust Fund (UITFs), and Variable Unit Linked (VUL) insurance. With funds pooled together, it’s easier to buy (and sell) various financial securities like bonds and stocks. The decisions are made by a fund manager (to be realistic, it’s a team). Dividend paying funds would then focus on getting positions that are oriented towards generating cashflow like interest payments from bonds or dividends paid by stocks.
Tradeoffs: Capital Growth vs Earnings
While there is no perfect investment, there’s always a tradeoff – you just have to ensure that what you’re getting is most meaningful to you. In the case of dividend paying funds, you get income paid out on a regular basis. However, this also means that you may be missing out on the compounding growth of your funds from reinvestment.
Dividend paying funds, if using stocks, would also tend to be positioned in mature companies. Companies that are seeking growth will typically pay lower or no dividends while its usually the stable companies that would pay out higher dividends. Because of the above reasons, dividend paying funds will have a smaller capital growth than nondividend paying funds.
Parting Words …
All in all, consider dividend paying funds as one of the tools in the box. We don’t use the hammer for everything, but it is good for its specific job. If your objective is to build your wealth especially as you still have a lot of time to earn and save, then opting for nondividend paying funds may be a better option. But if your goal is to enjoy passive income, then dividend paying funds are perfect for you.
Head of Investments
Henry Yang
Henry Yang is a Chartered Financial Analyst (CFA) holder and a graduate of the University of the Philippines with a degree in Electrical Engineering. He spent the initial years of his career in building maintenance, electrical design and installation of construction projects, and teaching engineering. Later, he pursued his Master's in Business Management from the University of the Philippines - Los Baños as well as held investment-related roles at a top local bank, a U.S.-based investment company, and a global insurance competitor. Currently, he serves as the Head of Investments at Allianz PNB Life Insurance, Inc.