Dividend Yield Funds: Meaning and Benefits

Investors look to dividend yield stock to invest in as this potentially generates capital appreciation and is a source of regular dividend payouts. Dividend payouts act as an income source. Dividend yield mutual funds can also generate dividend payouts besides giving investors income from the mutual fund investment itself. If you are an investor who wishes to make the most of dividend yield mutual funds that invest in the stock of companies with solid track records of delivering consistent dividends, this article explains the meaning of dividend yield funds and their advantages. 

What are dividend yield mutual funds?

Typically, companies that issue regular dividends are large corporations across Indian sectors. Mutual funds that invest in such dividend yield companies are referred to as dividend yield mutual funds. Such funds aim to provide investors with a consistent income via dividend payouts generated from the companies they invest in. The calculation of the dividend yield is done by dividing the yearly dividend payout by the price of the stock. A specific mutual fund portfolio holds the stock of many companies issuing dividends, so the average dividend yield is taken to decide the yield of that particular dividend yield mutual fund. 

Dividend yield mutual funds potentially invest in large companies in a variety of sectors like financial services, healthcare, consumer goods, and technology. Fund managers choose stocks based on the said fund’s investment strategy. If you are considering mutual fund investment offering a regular income flow, dividend yield funds are an option. 

Dividend Option vs Dividend Yield Fund

Although dividend yield mutual funds and dividend yield options may appear similar, they are different investment channels. The difference is explained below: 

• Dividend Option: Mutual funds offer the dividend option as a feature when you make a mutual fund investment, by which investors receive a part of the profits generated by the said fund as a periodic payout. Those investors who choose to receive the dividend option payout get regular payments via dividends that are paid through any mutual fund’s NAV (Net Asset Value). The sum of the payout and its frequency depends on the discretion of the mutual fund manager and the performance of the mutual fund itself. 
• Dividend Yield Fund: A dividend yield mutual fund is a mutual fund that invests your wealth in the stock of large corporations with a history of high dividend payments and solid financial backing. Such funds work with the goal of regular dividend distribution from the company stock the mutual fund invests in. 

The above financial instruments can be distinguished based on the following: 

1. Aims: The dividend option aims to give regular payments to mutual fund investors from the profits of the said mutual fund. In the case of a dividend yield fund, the aim is to deliver a regular income to investors, from the investment of stock of high-dividend paying corporations. 
2. Dividend Payments: Payments through a dividend option are decided and made by the mutual fund company. Payouts generated by dividend yield mutual fund investment are dependent on dividends declared by the companies whose stock is invested. 
3. Risk Involved: The dividend option payout is subjected to much less risk than payments sourced through dividend yield mutual funds, as the dividend yield option payments depend on the mutual fund’s discretion and performance. In contrast, dividend yield mutual fund payouts are based on market conditions and the volatility affecting the company stock. 
4. Taxability: The tax on any dividends received is liable to be paid at the hand of the investor. Therefore, when investors receive a dividend, it is taxed at source (TDS).

Features of Dividend Yield Funds

A dividend yield on mutual funds is a potential way to supplement your regular income. This is just one of the features of dividend yield mutual funds. If you wish to know other features, read below: 

• Fund Allocation: According to regulations of the Securities and Exchange Board of India, dividend yield funds have to allocate a minimum of 65% of their assets to stocks that yield dividends. 
• Dividend Payouts: Dividend yield fund payouts are provided as dividend payments, made consistently, to investors of such funds. These payouts are sourced from the stock of the companies that the fund invests in. 
• Investment in Large Companies: The best dividend-paying mutual funds invest in large companies with a robust track record of generating high and regular dividends. 
• Investment Aims: There are those dividend yield funds that have the main goal of capital appreciation, and others that deliver returns. Capital appreciation comes from those funds that invest in the stock of large corporations that issue high dividend payouts frequently. Other funds give high dividend payouts and profitable returns over time as these companies are blue chip firms with a history of solid financial/operational efficiency. 

How does a dividend yield mutual fund work?

Some of the potentially best dividend yield mutual funds work on the basic principle of assuring investors regular dividends. Therefore, fund managers of such funds select stocks depending on their ability to deliver high dividends. A large portion of dividend yield funds invest in the equity of large companies that generate dividends. When dividends are issued by the companies invested in the funds, the Asset Management Company (AMC) operating the fund collects the dividends and distributes them to investors according to investors’ respective investments in the fund. 

Factors to Consider Before Investing in Dividend Yield Funds

You may have heard that “mutual fund investment is subject to market risk”, but this should not deter you from investment. However, here are key factors to think about before investing: 

• Performance of the Fund: As with any mutual fund investment, you must assess the past performance of the said fund. You may want to consider a fund’s performance in the past 1, 3, and 5 years to give you clues about future prospects. 
• Experience of the Fund Manager: The fund manager is responsible for selecting the appropriate dividend yield stocks for your dividend yield mutual funds. Their track record and experience play an important role in the potential success of the fund. 
• Strategy of Investment: Different dividend yield funds tend to follow distinct strategies concerning investment in dividend yield stock. While making a mutual fund investment in a dividend yield fund, investors must be sure that a mutual fund’s investment plan matches with their financial goals.
• Charges: When you make any mutual fund investment, there are certain charges involved. These are in the form of expense ratios. Expense ratios may potentially affect the returns of any fund if they are high. 
• Taxation: Dividend yield funds are liable for taxation if their returns, in the form of dividends, cross certain limits. Before investing, consider potential tax implications. 
• Risk: While you may think that dividend yield funds pose minimal risk, all investments bring risk. Any mutual fund investment must be made according to your unique risk profile. 

How should you invest in a dividend yield mutual fund?

You can invest in dividend yield mutual funds through any depository participant/broker or an AMC directly. You can do this online by submitting KYC documents like your PAN and other relevant documents. Online payments can be made once you choose your fund and the amount to invest. 

Who should invest in dividend yield funds? 

Dividend yield mutual fund investment may be undertaken by investors looking for regular and consistent income streams. Consequently, dividend yield funds may be considered by long-term investors, retirees or those investors approaching retirement, investors wanting tax efficiency with returns, and risk-averse investors. 

Why should you invest in a dividend yield fund?

The best dividend-paying mutual funds potentially give you enough reason to invest. For instance, if investors are looking for a regular source of income, and are risk-averse, they may consider dividend yield funds. Such funds invest in the stock of tried and tested companies with a background of strong financials and performance over time, and yield capital appreciation over a period while delivering dividends in the interim. 

Taxation Rules of Dividend Yield Mutual Funds

Dividend income from mutual fund investment is taxed at the hands of the investor as this is considered an income that the investor earns. Furthermore, the tax applicable is charged according to the investor’s respective tax slab. 

Conclusion

Dividend yield mutual funds offer investors a means to earn a regular income and they are particularly beneficial for retirees who may want to supplement their other income sources. However, before you make any investment decisions, mutual funds should be researched and evaluated so that fund selection is based on an investor’s distinctive risk profile and investment objectives.

SIPs let you invest small amounts regularly, making it easier to stay consistent with your goals. With time, your money grows faster through compounding, helping you get the most out of your investments. Try our SIP Calculator to see how your money can grow and make smarter plans for your future.