Yield Tilt Index Fund

What Is a Yield Tilt Index Fund?

A yield tilt index fund is a type of fund that invests in stocks or securities that mirrors the holdings of a market index but contains a higher weighting towards higher-yielding investments. A yield tilt index fund can be a mutual fund, which is a basket of securities that are actively managed by a portfolio or fund manager.

A yield tilt index fund can also be an exchange-traded fund (ETF), which merely mirrors an index of stocks.

How a Yield Tilt Index Fund Works

Typically, an index fund would contain all of the stocks of a particular stock index, such as the Standard & Poor's 500 Index (S&P 500). Investors can't buy an index per se, since it's merely a tracking mechanism containing a collection of stocks designed to provide investors with the overall trend for those stocks.

Instead, investors would need to buy a fund that contains all of those stocks within the index. For example, there are ETFs that contain all 500 of the stocks in the S&P 500. However, if investors want to own the index, while also increasing their return, they can invest in a tilt fund.

Tilted funds contain all of the stocks of a benchmark index but are enhanced with investments that tilt the fund in the direction of a specific investment strategy or financial goal. For example, many stocks pay dividends, which are usually cash payments paid to investors as a reward for owning a stock. A tilted fund might mirror an index but also contain more shares of the stocks that pay high dividends.

Yield Tilt Index Fund Weighting

A yield tilt index fund enhances the income of a standard index fund by weighting its holdings towards stocks that pay higher dividends. In other words, attractive dividend-paying stocks are given a greater portfolio weighting, making them represent more of the fund's portfolio than they otherwise would in the standard index. The fund's yield is “tilted” due to the heavier weighting in that direction.

In this way, the fund is tilted towards earning higher-than-normal dividend income, while also keeping with the overall investment strategy of owning the benchmark index.

Benefits of Yield Tilt Index Fund

A yield tilt index fund allows for the fund to be able to outperform the yield from the baseline fund. Also, many dividend-paying stocks are of well-established companies since they need to generate consistent earnings to keep up with paying quarterly dividends.

As a result, a fund that's tilted toward dividend-paying companies can also enhance the returns from the investments in the fund since it's overweighted with more profitable companies.

Since the investment strategy of a yield tilt index fund uses a baseline benchmark index, the fund is diversified, meaning the invested dollars are spread out over many companies. This diversification reduces the risk of loss if a few of the companies within the fund fall into financial difficulties. The other remaining companies can still outperform, which partially offsets the drag on the fund from the underperformers.

Since the fund is merely tilted towards dividend-paying stocks, the fund can continue to keep pace with the direction of the overall market, while boosting dividend income with little additional risk.

Yield Tilt Index Funds and Taxes

The structure of a yield tilt index fund can offer some tax benefits for investors who are seeking a way to minimize the tax liability associated with their holdings. Dividend payments issued to shareholders can be subject to double taxation. This means that they are taxed once at the corporate level and then once again at the shareholder level. So the investor is essentially paying income taxes twice on the same single amount of income.

Proponents of this taxation structure see it as a way to ensure the wealthy are paying their fair share, and cannot get rich off their investment earnings without paying a sufficient amount of taxes in return. Opponents, on the other hand, contend that this dual-level taxation is unfair and imposes an additional penalty on successful investors.

Tax Shelter Strategy

Due to the effect of double taxation, some investors contend that the market must value the share prices of high-yield stocks at somewhat of a discount to other stocks, so as to provide an increased return on high-yield stocks in order to compensate for the negative tax effects. The theory is that an investor who is able to purchase a yield tilt index fund in a tax-sheltered investment account—such as a retirement account—might be able to outperform the index since they receive the supposed valuation benefit but are sheltered from taxes on the dividends they receive.

This strategy would be a potentially smart option for a sophisticated investor who understands the intricate details of this structure, is familiar with the tax regulations involved, or has a financial advisor who is well-versed in the tax code.

How to Invest in a Yield Tilt Index Fund

Investors will find that the tax-advantaged strategy of holding yield tilt index funds in tax-sheltered accounts means that they will be purchasing these types of funds as an ETF. The investor would purchase the ETF through the custodian who manages their tax-sheltered account such as Schwab, Fidelity, or maybe a robo-advisor.

From that point, the security is purchased and all an investor needs to do is let the dividend strategy develop in their account. A common tax-advantaged account that could use this strategy would be a Roth IRA. Many investors will choose to purchase these funds through their brokerage account instead of with the fund directly, as the index fund they intend to purchase is usually only a portion of their portfolio. Having a brokerage account allows for greater purchasing diversity versus investing with the fund directly, although often at the cost of additional fees, such as trading commissions.

The Bottom Line

Yield tilt index funds can be a great way for investors to track an index while also pursuing dividend-based strategy goals. These types of funds offer the risk-averse nature inherent in diversification while providing a lean, or tilt, towards those companies who produce regular dividends. Investors looking to reinvest dividend growth back into their portfolio, such as with a dividend reinvestment plan (DRIP), should consider tilt funds to meet their investment objectives.