What are Dividend Mutual Funds 2022 – Advantages, Types & How It Works
Individuals invest in mutual funds for various reasons. Some invest for the long term for capital appreciation to fulfil their financial goals. Some individuals invest for regular income in the form of regular dividends. Some invest for a combination of capital appreciation as well as regular dividends. A dividend yield fund can provide this combination of regular income and capital appreciation. This blog will focus on what are dividend mutual funds – Advantages, types & how it works.
What are dividend mutual funds?
As per SEBI guidelines, a dividend yield fund is an open-ended equity mutual fund scheme that predominantly invests in dividend-yielding stocks. They have to invest a minimum of 65% of their total assets in equity shares. Dividend yield funds are a subcategory under the broader category of equity mutual funds.
The funds invest in dividend-yielding stocks across market capitalisation, sectors, themes, etc. So, the funds invest in a mix of large, mid, and small-cap companies paying dividends. They also invest in stocks across diverse sectors such as Information Technology (IT), pharma, oil and gas, financials, etc., as long as the stocks fulfil the dividend-paying and other criteria.
Who should invest in dividend yield mutual funds?
A dividend yield mutual fund is suitable for an investor looking for investment in a diversified portfolio of dividend-yielding companies and capital appreciation in the long term. The risk profile of a dividend yield mutual fund scheme is relatively lower than other equity mutual funds in the medium to long term.
Dividend-paying companies have a stable business model with free cash flows. The business is usually low capital intensive; as a result, the free cash flows can be used for dividend payment or share buybacks. Companies that consistently increase their dividend pay-out ratio indicate their profits are growing consistently, making them investment worth candidates.
Usually, when the overall stock market is falling, the fall in share prices of dividend-yielding companies is relatively lower than other stocks. Similarly, when the stock market is recovering from a fall, dividend-yielding companies usually recover faster than other stocks. Hence, a dividend yield fund is a good investment product to have in your overall investment portfolio.
How do dividend yield mutual funds work?
A dividend yield mutual fund initially raises money from investors during the new fund offering (NFO) period. The money is deployed in dividend-yielding stocks. The stocks are chosen across market capitalisation, sectors, themes. The main criteria for stock selection are the company's past dividend payment track record. Apart from that, the fund manager looks at other parameters such as fundamentals of the company, future growth outlook, corporate governance standards followed, valuation, sector outlook, etc., for making an investment decision.
The scheme investors are allotted units in proportion to their investment. The net asset value (NAV) of the scheme depends on the value of the scheme's underlying assets. The fund house declares the scheme NAV at the end of every business day. The unitholder's profit or loss depends on the difference between the current NAV and the price at which they bought the units.
Investment options in dividend yield mutual funds
An investor can opt for the growth option, dividend option, or the dividend reinvestment option. In the dividend option, any mutual fund dividends declared by the scheme are paid out to investors. In the dividend reinvestment option, the dividend amount is re-invested on behalf of the investor, and they are allotted fresh units.
Advantages of dividend mutual funds
As discussed earlier, usually, companies that pay dividends regularly tend to fall less than other companies during an overall market fall. Similarly, during an overall market recovery, usually, dividend-paying companies recover faster than other companies. As dividend yield funds invest in these dividend-paying companies, their NAV fall is usually lower than other equity funds during an overall market fall. Similarly, during an overall market recovery, usually, their NAV rises faster than other equity funds.
The fund also gets regular income in the form of dividends from the dividend-paying companies it has invested in. It ensures regular dividend income flow into the scheme and supports the scheme NAV.
Disadvantages of dividend mutual funds
A company usually pays regular dividends and consistently increases the dividend pay-out ratio when it sees limited or no growth opportunities. During such times, companies usually return the cash to investors through dividends or buybacks. A dividend yield fund invests in such companies. It may signal low to no growth opportunities in the scheme portfolio companies. It may limit the growth in the share prices of these companies, which may lead to limited NAV appreciation of the scheme.
Taxation of dividend yield funds
From a taxation point of view, any mutual fund scheme with a minimum of 65% of its total assets in equity and equity-related instruments is classified as an equity scheme. Dividend yield funds are treated as equity funds and taxed accordingly.
Short-term capital gains (STCG) tax: If you sell your dividend yield mutual fund units within twelve months of purchase, the capital gain will be classified as short-term capital gain (STCG). The short-term capital gain (STCG) tax will be levied at 15%.
- Long-term capital gains (LTCG) tax: If you sell your dividend yield mutual fund units after twelve months of purchase, the capital gain will be classified as long-term capital gain (LTCG). Every financial year, the first Rs. 1 lakh long-term capital gain will be exempt from taxation. The incremental long-term capital gain above Rs. 1 lakh will be taxed at 10%.
Performance of dividend yield funds
(Direct Plan - Growth option)
|Templeton India Equity Income Fund||1,215||30.67%||21.76%||16.62%|
|Sundaram Dividend Yield Fund||243||20.26%||17.65%||15.79%|
|UTI Dividend Yield Fund||2,914||25.90%||18.02%||15.00%|
|ICICI Prudential Dividend Yield Equity Fund||795||35.98%||18.85%||13.41%|
|Aditya Birla Sun Life Dividend Yield Fund||812||29.25%||17.41%||10.83%|
How to invest in dividend yield funds
You can invest in dividend yield funds through the Glide Invest App. If you have already shortlisted a specific dividend yield fund for investment, you can read about it on the App and proceed with your investment. If you haven’t shortlisted any specific fund, you can go through the listed dividend yield funds and read about them, and choose an appropriate one for investment.
The Glide Invest App will recommend the investment based on your risk profile, financial goals, investment time horizon, etc. You can partner with the Glide Invest App for your financial planning journey to get recommendations for the appropriate mutual fund schemes based on your risk profile. You will get advice on planning and systematically investing towards your financial goals.
With Glide Invest, you will get guidance for:
- A personalised risk profile assessment
- Identifying your financial goals
- Appropriate asset allocation
- Making a financial plan for each goal
- Automating the financial plan
- Review and analysis of your financial plan
- Hand holding you till your financial goals are achieved