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What are dividend yield mutual funds?

What are dividend mutual funds and how do they work? Discover all about dividend mutual funds, its benefits, taxation and how to invest in them. Click to know more.

When you invest in equity-linked instruments like a mutual fund, a mutual fund dividend is crucial to your investment, and its returns. Companies whose stock (equity) you invest in share a part of their profits with stockholders by way of declaring dividends at specific times. A dividend yield is a dividend which is paid for each unit, divided by the stock’s market price. Essentially, dividend yield mutual funds are basically equity funds that invest in the equity of companies known to generate high dividends. Therefore, these are companies that make substantial profits, easily identifiable by their excellent historical data.  

Typically, the investment of a dividend yield fund comprises about 70%-80% equity shares whose dividend yield is higher than the benchmark of the markets. Mutual fund dividends from such shares are set apart from other dividends that do not make the cut. Therefore, fund managers can easily identify dividend yield funds. It should be noted that companies which pay high dividends are those with stability and solid cash flows. 

Types of Dividend Yield Mutual Funds

It is important to be aware of the fact that the criterion for a company to be included in a dividend yield mutual fund is not just a high mutual fund dividend, but a high yield of dividends. Hence, you have to consider a stock in terms of its dividend and market price. A stock may pay you great dividends, but the stock’s market price may be extremely high. In such cases, a dividend yield mutual fund will not invest in such a stock. A fund manager may also factor in the types of funds, and these are broadly categorised into two kinds. The classification is based on returns generated, assets allocated, etc, as follows: 

  • Equity Dividend Yield Mutual Funds - Such a fund allocates a large part of its assets, amounting to above 65%, to equity. Such funds, due to the asset of equity, are considered volatile, but gainful in the long run. 
  • Debt Dividend Yield Mutual Funds - These funds allocate a large part (65% and above) of their assets to debt instruments. These funds tend to have less volatility as they invest in market bonds, or generate returns through interest on debt/bond holdings. Mutual fund dividends generated from these may be lower than those from equity-related funds.  

Advantages of Dividend Yield Mutual Funds 

Dividend yield mutual funds can help you in many ways with the following advantages you get from investing in them: 

  • A consistent flow of high dividends implies a regular and stable income source for investors. . 
  • Dividend yield mutual funds can mitigate risks associated with volatility of the markets, acting as a hedge to combat sudden market shifts. In any single fund, some companies may be affected, while others make up for losses. 
  • Dividend yield mutual funds offer substantially better investment yields from a long-term standpoint. This is because fund managers choose blue chip shares for allocation in the fund portfolio. Again, these are companies with reputable backgrounds and hence, give an investor a mutual fund dividend which is always on the high side. 

Disadvantages of Dividend Yield Mutual Funds 

While returns may be high in the long run, these funds come with some disadvantages, if you view them from a certain perspective: 

  • A mutual fund dividend payout from such funds may not necessarily indicate that companies are prosperous. Thus, misconceptions may occur, as it is the yield that counts most. 
  • Dividends that investors receive are not free from any tax liability on the investor’s part. The investor will have to pay tax according to the tax slab applicable to returns gained via dividends. 
  • As dividends generated depend on company profits, although companies are sound, fixed profits/returns can never be guaranteed. 
  • When the trend of the market is bullish, dividend yield mutual funds usually underperform. You may get no mutual fund dividend then. 

How Dividend Yield Mutual Funds Work

When you select a dividend yield mutual fund for investment, the returns you earn from that investment are in the form of mutual fund dividends. These are declared by the underlying blue chip companies whose stocks are invested. In such a case, dividends are received directly by the investor from the fund manager. The fund manager must dispatch a declared dividend warrant within one month of the dividend’s declaration. In case dividends are delayed, the fund house has to pay interest as a penalty. 

In some dividend yield mutual funds, investors can have options to reinvest mutual fund dividends. Thus, the fund manager allocates the amount of the dividend to purchase more stock in the fund. This is a good way to compound wealth and earn higher returns in the future. 

How to Invest in Dividend Yield Mutual Funds 

If you wish to invest in a mutual fund dividend yield fund, you can do so directly, contact banks, or fund agents. When you finally make your investment in dividend yield funds, make sure to do so via the Association of Mutual Funds in India that has registered agents. If you make your investments through agents or distributors, you may have to pay a commission. However, if you directly approach the mutual fund house or invest in a mutual fund online, you avoid any middlemen, and stand to save money. When you visit the website of the fund you are interested in, you will get details of the fund online. 

Nonetheless, before you sign up and enjoy any fruitful mutual fund dividends, you should do your own due diligence and research the companies that are included in your potential fund. You must also make it a point to find out the nature of the fund you wish to invest in, and whether it suits your needs (long-term, short-term, mid-term, with regular payouts, etc.). Another factor worth considering is the risk involved and this depends largely on the companies you research on. 

When are dividend yield mutual funds paid to investors?

By law, a mutual fund dividend has to be paid to investors at least once in a year. Apart from this, different dividend yield mutual funds may pay dividends on a regular basis, either monthly, quarterly, etc. Some companies included in mutual funds may choose to give dividend payouts just once or twice in a year. This is primarily done to reduce administrative expenses. There are different dividend yield mutual funds on the market, and you can make your choice based on the frequency of dividend payments matching requirements. 

Tax Implications of Dividend Yield Mutual Funds 

Dividends that are paid by dividend yield mutual funds of equity are subject to tax that has to be borne by the investor. If a mutual fund dividend payout is made to any investor, they are taxed according to certain tax slabs. When the mutual fund dividend is paid to an investor, for tax filing purposes, it is considered as part of the income earned by an investor, and is taxed accordingly. As individuals are taxed based on different tax slabs of income earned on an annual basis, dividends are included as part of the total income earned by the individual. Furthermore, TDS is also deducted before a dividend is paid to an investor. 

FAQs

  1. How can I be certain that a fund manager has invested my wealth in dividend yield mutual funds?

Mutual funds are required to fully disclose portfolios of all schemes in the funds, as per rules of SEBI. The mutual fund concerned is required to do this on its website.

  1. Can a non-resident Indian invest in a dividend yield mutual fund?

This is possible, and offer documents have details pertaining to this. 

  1. What should be the proportion of equity and debt in a dividend yield mutual fund?

The proportion of different instruments depends entirely on an investor’s individual needs and what the fund ultimately offers. If you are risk-averse, then debt is better, but if you can afford risks, equity is good.  

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