Testing dividend funds

Here, the same rules apply as with any fund. Go with managers who have good track records and long tenures, so that they've been tested in different kinds of markets, says Christopher Davis at Morningstar. That means at least five to seven years. Next, look for low fees -- 1% or less for a domestic fund with an active manager picking stocks, and 0.3% or lower for index funds, as a general rule.

With these guidelines in mind, I hunted through Morningstar's database to find funds that rank among the best performers in this category.

For the superlow-cost approach, consider the Vanguard Dividend Appreciation (VDAIX) fund. It tracks a proprietary index of companies that have increased dividends in each of the past 10 years. The fund pays a 2% dividend yield, but its holdings are likely to raise dividends nicely because they have solid expected earnings growth, says Ryan Leggio, of Morningstar.

Among managed funds, Rochdale Dividend & Income, Icon Equity Income, and Neuberger Berman Equity Income Institutional Fund (NBHIX), all rank high for three or five-year performance. They pay yields ranging from 3.8% to 4.25%. Rochdale Dividend & Income charges a load, or entrance fee, of 5.75%, but its consistently solid outperformance might make up for that, if it continues. The fund has beaten peers by an impressive 5.2 percentage points a year, annualized, over the past five years, according to Morningstar.

I'd also suggest breaking one of the rules to consider a newcomer, the THodges Equity Income Retail (HDPEX) fund, because of its results. The fund has outperformed peers by 5.6 percentage points over the past year. It pays a 2.7% yield.

For utility funds offering high yields, consider the Icon Telecommunications & Utilities (ICTUX). It charges a little more in expenses than I'd like, but it has outperformed peers by an annualized 5.4 percentage points a year over the past 10 years, according to Morningstar. The Gabelli Utilities AAA (GABUX) fund pays a 13.7% yield and outperforms peers by more than a percentage point a year, annualized over the past 10 years.

You shouldn't have much problem getting one or more of these into your IRA; if your 401k doesn't offer them, look at your plan's offerings based on the criteria above.

Now, let's look at some of the top dividend-paying stocks that the managers of these funds favor, and their yield, or payout, as I was putting this column together:

AT&T: 6.1% yield

AT&T (T, news) is often the butt of jokes about dropped calls. These customer service issues, and concerns about the economy, help explain why its stock trades where it did in early 2009. But AT&T's stock weakness means a high yield. And AT&T remains a dominant player in wireless, where demand is going to keep growing. "This is one of the more stable cash cow businesses right now in the U.S.," says Abella.

McDonald's: 2.8% yield

McDonald's (MCD, news) has one of the strongest brands in the world, and it's expanding in emerging markets. At home, McDonald's has had solid success rolling out new offerings; it's also upgrading restaurants and offering free Wi-Fi to get customers in the door. Stable cash flow and growth should mean regular dividend increases ahead. This probably explains why McDonald's is the top holding of the Vanguard Dividend Appreciation Index fund.

Bristol-Myers Squibb: 4.5% yield

Lots of major pharmaceutical companies pay high dividends and look cheap right now, because their stocks have been beaten down by concerns about patent expirations on blockbuster drugs. But Bristol-Myers Squibb (BMY, news) stands out as the premier yield play in this space because it has a much better pipeline of drugs in development, says Abella. "Bristol-Myers Squibb is a way to play the attractive valuations in pharma with less pipeline risk," he says.

Philip Morris International: 3.8% yield

Cigarettes are terrible for your health, and people shouldn't smoke. But if you can get around the qualms, Philip Morris International (PM, news) is a great yield play. Philip Morris sells powerful brands like Marlboro in dozens of markets outside the U.S., producing enormous cash flow to back dividends. That's why Abella has found a place for Philip Morris in his dividend portfolio even though, like me, he's not a big fan of smoking.

Southern Copper: 7.9% yield

Based in Phoenix, Southern Copper (SCCO, news) is one of the world's largest copper producers. It has low debt for a mining company, which helps make the sweet 7.9% dividend yield more secure. This is a favorite of Rollingson, at Icon Equity Income Fund. Rollingson estimates Southern Copper trades 22% below fair value.

Union Pacific: 2.1% yield

The largest publicly traded railroad in the U.S., Union Pacific (UNP, news) operates in the western part of the country, hauling everything from coal and chemicals to toys from China. Shipping by rail is less expensive for long distances than trucking, which means Union Pacific should continue taking market share, says Eric Marshall, an analyst with the Hodges Equity Income Retail fund. The railroad's recent 25% dividend hike and ongoing large share repurchases are signs that management is confident about the future.

Utilities

No dividend portfolio is complete without utilities. And the wild days of Enron are over; utilities are generally safe investment plays once again, says Mario Gabelli, of the Gabelli Utilities AAA fund.

Two that look particularly secure are Wisconsin Energy (WEC, news), which pays a pays a 3.3% yield, and CH Energy Group (CHG, news) in Poughkeepsie, N.Y., which pays a 4% yield, says Tim Winter, who follows utilities for the Gabelli Utilities AAA Fund. Both utilities are likely to raise dividends, he says.

Robert Straus, of the Icon Telecommunications & Utilities fund, thinks two other utilities stand out because they are trading at significant discounts to his calculation of their fair value. One is Southern (SO, news), his fund's largest holding. It pays a 4.5% yield. The other is Duke Energy (DUK, news), a top-10 position in his fund. It pays a 5.5% yield. Both companies have paid dividends consistently since the late 1970s.

Stocks for your retirement

The hitch here, of course, is that if your nest egg is in a 401k, you're probably not allowed to put stocks in it. You'd need to open up a self-directed brokerage account inside your 401k, something more employers are allowing, says Dave McDonough of Flagship Wealth, a financial advisory firm in Quincy, Mass. So ask at work, but realize it's a major change.

Here's an easier way: If, like most of us, you're a little behind in your retirement saving, consider buying these dividend stocks above in a private retirement fund to supplement your 401k, while also looking for dividend funds in your plan.

And of course, there's no guarantee any investment will pay off for you, not even those that pay dividends. But I've tried to stick here with picks recommended by top experts and funds with very solid records that look likely to keep the dividend payouts rolling. Keep an eye on any investments you buy to make sure they do.

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Because a steady stream of dividend payouts will keep your nest egg growing, even while the market remains flat.

At the time of publication, Michael Brush did not own or control shares of any company or fund mentioned in this column. In the past year, he has suggested that his newsletter subscribers consider purchasing shares of Philip Morris International.

Michael Brush is the editor of Brush Up on Stocks, an investment newsletter. Click here to find Brush's most recent articles and blog posts.