What Are Dividend Yield Mutual Funds

Here’s everything you need to know about Dividend Yield Mutual Funds to make informed investment decisions.
Dividend Yield Mutual Funds
4 mins
12 Feb 2024

Dividend yield funds are a type of mutual fund that invests in companies that have a history of paying high dividends. These funds aim to generate income for investors by investing in high-dividend-yielding stocks. As per SEBI, a dividend yield fund must invest minimum 65% of its assets in equity and its associated instruments. In this article, we will discuss the basics of dividend yield funds, their advantages and limitations, and factors to consider before investing in them.

How does a Dividend Yield Mutual Fund work?

A dividend yield mutual fund typically allocates its investments into equities of companies known for their higher dividend payouts. These funds specifically target firms with a history of increasing dividends or offering substantial dividend yields.

Conversely, a mutual fund featuring a dividend option may not suit every investor, primarily because its Net Asset Value (NAV) doesn't experience rapid growth. This scenario arises when dividends are promptly distributed once a specific threshold is met.

Therefore, dividend yield mutual funds are most suitable for investors with a low-risk tolerance who seek regular monthly payouts as a dependable income source.

Dividend Option vs. Dividend Yield Fund

Dividend option and dividend yield funds represent distinct categories within mutual funds. Mutual funds provide investors with two primary options for receiving returns – growth option and dividend option.
Growth option mutual funds are investment vehicles that focus on capital appreciation over regular income distribution. In these funds, the profits generated are reinvested, leading to an increase in the fund's Net Asset Value (NAV).
Dividend yield funds, on the other hand, invest in companies that have a history of paying high dividends.

Who should invest in a dividend yield mutual fund?

Dividend yield mutual funds are ideal for investors who are looking for a regular source of income. These funds are also suitable for investors who want to invest in equity but are looking for lower volatility.

Advantages of dividend yield funds

Dividend yield funds offer several advantages to investors, as listed below:

  • Diversification
    Dividend yield funds invest in a diversified portfolio of stocks, which helps to reduce the risk of investing in a single stock.
  • Lower risk
    Dividend yield funds are less risky than other forms of equity mutual funds, which makes them low-risk funds and most suitable for investors who have a low-risk appetite.
  • High yield in the long term
    Dividend yield funds aim to generate income for investors by investing in high-dividend-yielding stocks. These funds offer a high yield in the long term.
  • Ideal for new investors
    Dividend yield funds are ideal for new investors who are looking for a regular source of income.

Limitations of dividend yield funds

While they carry several advantages, dividend yield funds are not immune to inherent risks. Here are some of their limitations:

  • Limited Capital Appreciation
    Dividend yield funds primarily focus on income generation, potentially limiting their capital appreciation compared to growth-oriented funds. Investors seeking substantial capital gains may find these funds less suitable for their objectives.
  • Not Suitable for Short-Term Goals
    These funds are typically more suitable for long-term investors seeking regular income. For investors with short-term financial goals, the fluctuation in dividend payouts may not align with their income needs.

Factors to consider before investing in dividend yield funds

Before investing in dividend yield funds, investors should consider these factors:

  • Risk tolerance
    Investors should consider their risk tolerance before investing in dividend yield funds. It is suggested to properly understand the market and economic risks and then make your investment choice.
  • Tenure of the fund
    Investors should look into the duration of the fund’s investment tenure. A dividend yield fund that has seen the stock market’s bull and bear phases will provide a higher return than newer companies.

Taxation of Dividend Yield Funds

Following the amendments introduced in the Union Budget 2020, dividends distributed by mutual funds are now subject to taxation based on the investor's income tax slab. Additionally, the taxation rate on capital gains generated by these funds relies on the duration of holding and the extent of equity exposure within the fund.

When the equity exposure surpasses 65%, the taxation regulations applicable to equity funds come into effect. Conversely, if the equity exposure falls below this threshold, the taxation rules of debt funds are applied. Hence, it's essential to be aware of the fund's equity exposure before investing, as this enables more effective tax planning strategies.

How to invest in Dividend Yield Funds?

Step 1: Click on INVEST NOW. You will be redirected to the mutual funds listing page.
Step 2: Filter by scheme type, risk appetite, returns, etc. In this case ‘Dividend Yield Funds’.
Step 3: All the mutual funds of the particular category will be listed, along with the minimum investment amount, annualised return, and rating.
Step 4: Get started by entering your mobile number and sign in using the OTP.
Step 5: Verify your details using your PAN, date of birth. If your KYC is not complete, then you will have to upload your address proof and record a video.
Step 6: Enter your bank account details.
Step 7: Upload your signature and provide some additional details to continue.
Step 8: Choose and select the mutual fund that you want to invest in.
Step 9: Choose whether you want to invest as SIP or lumpsum and enter the investment amount. Click on ‘Invest Now’.
Step 10: Select your payment mode i.e., net banking, UPI, NEFT/ RTGS.
Step 11: Once your payment is done, the investment will be complete.
Your investment will start reflecting in your portfolio within 2-3 working days.

Conclusion

Dividend yield funds are a type of mutual fund that invests in companies that have a history of paying high dividends. These funds aim to generate income for investors by investing in high-dividend-yielding stocks. Dividend yield funds offer several advantages; however, investors should also consider the limitations of dividend yield funds, before putting in their money.


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Frequently asked questions

Can the dividends declared by the company be re-invested in the fund?

Yes, the dividends declared by the company can be re-invested in the fund, either by opting for the reinvestment option.

Does a high dividend-paying company always indicate a cash-rich company?

Not necessarily, a high dividend-paying company may also indicate a mature company with limited growth opportunities, or a company that wants to attract investors by rewarding them with dividends.

What are the pointers for an ideal dividend yield fund?

Some pointers for an ideal dividend yield fund are: consistent dividend payout history, low expense ratio, diversified portfolio, stable performance across market cycles, and good fund manager.

How does the fund house select 'high dividend' companies?

The fund house selects ‘high dividend’ companies based on their dividend yield, which is the ratio of the annual dividend per share to the current share price, expressed in percentage. The fund house may also consider other factors such as the company’s earnings, cash flow, growth prospects, and valuation.

Do dividend yield funds only invest in high dividend companies?

No, dividend yield funds do not only invest in high dividend companies. According to the rules set by SEBI, a dividend yield fund has to invest at least 65% of its assets in equity and equity-associated instruments. The remaining 35% can be invested elsewhere.

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