What Is Equity Income?
Equity income primarily refers to income from stock dividends, which are cash payments from companies to their shareholders as a reward for investing in their stock. In other words, equity income investments are those known to pay dividend distributions.
- Equity income is money earned from stock dividends, which investors can access by owning dividend-paying stocks or funds.
- Income-paying stocks or funds are typically preferred by more conservative investors looking for long-term income.
- Investors interested in equity income should look to quality stocks that have a high dividend yield—both the trailing and forward yield.
- Investors should consider if the stock or fund has a dividend reinvestment program and any tax implications.
Understanding Equity Income
Stocks are the most common type of equity income investment. Companies generally pay dividends when they have limited investment opportunities and excess cash available as a way to reward shareholders, attract investor capital, and support their share prices. Equity income investments offer an additional return component to capital gains, helping to compensate for a lack of explosive growth potential.
Dividend-paying companies are typically large, well-established companies with mature revenue and earnings. Most dividend-paying companies also have a well-established commitment to paying shareholders dividends with a targeted annual dividend payout rate factored into their corporate financial planning.
Mutual funds and exchange-traded funds (ETFs), which are investment vehicles that contain a basket of securities, can be managed with a focus on equity income. These funds invest in dividend-paying stocks.
Large and established companies—called blue chips—often provide high dividend payments. The Dow Jones Industrial Average contains 30 blue-chip stocks, some of which pay lucrative dividends.
Equity Income Investing
Income-paying companies are often favored by moderately conservative investors. They may also be sought by investors specifically seeking income investments. Dividend income-paying companies tend to be value stocks that investors seek to hold long term.
Equity income funds are also popular for the same reasons. Most large investment managers will typically have equity income fund offerings because of their high demand. The objective for most equity income funds will be to invest for capital appreciation and income. Therefore, they seek stocks with value appreciation that also have an equity income component.
Vanguard offers some of the best dividend-paying funds for a relatively low expense ratio. These funds track an index of stocks that often pay an attractive dividend.
An equity-income investment’s dividend yield is a top characteristic considered in equity income investing. Stocks and funds will have a trailing and forward dividend yield that helps investors gauge the payout as a percentage of the price.
Successful income investing isn't just about hunting down the highest yields, though. Investors should consider how sustainable the dividend is, the potential for payouts to grow, and whether there is a dividend reinvestment plan (DRIP) that allows them to reinvest the dividends in fractional shares of the stock or fund.
Taxes are another important consideration. Investors must pay taxes on equity income received from stock and fund investments regardless of whether or not the distributions are reinvested.
Examples of Equity Income
Below are two equity income investments in the market as of May 2023.
International Business Machines
International Business Machines (IBM) is one of the highest-yielding dividend stocks. On May 9, 2023, it was paying a dividend yield of 5.48%.
Vanguard Equity Income Fund (VEIPX):
Those who don't want to invest in individual stocks can opt for a mutual fund that diversifies their investment by owning stocks of various companies. VEIPX is a popular mutual fund for income investors. It focuses primarily on U.S. companies that are consistent dividend payers and tends to invest in slow-growth but high-yielding stocks.
The fund pays regular quarterly dividends with an SEC yield of 2.66%, as of April 30, 2023. The fund has a low expense ratio of 0.28% and a $3,000 minimum investment requirement.