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:
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.
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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