Dividend Yield Mutual Fund

When investing, finding the right balance between growth and stability can be challenging. While some funds prioritise growth, they may fall short on stability, and vice versa.

Dividend yield funds are designed to strike a balance between these two aspects. They invest in companies known for paying consistent dividends and also possessing potential for capital appreciation. These companies tend to be well-established and financially stable and are known for distributing a portion of their profits as dividends to shareholders.

This article will explore what dividend yield funds are, discussing their benefits and risks, how these funds operate, and who should consider investing in them.

What is a Dividend Yield Mutual Fund?

As per guidelines set by SEBI, dividend yield funds are classified as equity-oriented mutual funds and are mandated to allocate a minimum of 65% of their assets to stocks that regularly pay dividends. The primary aim of these funds is to provide investors with steady dividend income, along with the possibility of capital gains.

Unlike growth-oriented funds, which focus solely on capital gains, dividend yield funds offer a combination of growth and income. The dividends paid by the underlying companies are either distributed to the investors or reinvested, depending on the investor's preference.

Features of Dividend Yield Funds

Dividend yield funds offer a range of unique features, including:

Income Generation: The primary feature is the focus on generating income through regular dividend payouts from the stocks in the portfolio.

Equity-Oriented Funds: Though they prioritise dividends, these funds primarily invest in equity or equity-related instruments, which means they still have growth potential.

Risk Mitigation: The companies chosen for these funds tend to be well-established, dividend-paying firms, reducing the overall risk compared to growth stocks.

Dividend Reinvestment: Investors have the option to reinvest dividends received back into the fund to compound returns over time.

Diversification: These funds invest in a variety of high dividend-yielding companies across sectors, providing diversification to the portfolio.

How Does a Dividend Yield Fund Work?

Dividend yield funds work by pooling money from multiple investors and investing in a portfolio of high dividend-paying stocks. Fund managers typically select companies with a proven history of paying consistent dividends. These companies are generally more stable and less volatile, focusing on returning a portion of their profits to shareholders.

Once the dividends are distributed by the companies, the mutual fund passes them on to the investors. These investors can either receive these dividends as a payout or reinvest them to purchase additional units of the mutual fund. The value of the fund also increases as the underlying stocks appreciate over time, offering a mix of income and growth potential.

Advantages of Dividend Yield Funds

There are several advantages to investing in dividend yield funds:

Steady Income: Investors receive a consistent income stream through dividends, which can be particularly appealing during periods of market volatility.

Compounding Advantage: Dividend yield funds provide an option to reinvest dividends, enabling you to acquire more shares with the dividends you receive. This reinvestment can significantly enhance the growth of your investment over time through compounding.

Lower Volatility: Companies that consistently pay dividends tend to be more stable and less volatile than growth-focused companies.

Reinvestment Option: Investors can reinvest their dividend payouts, allowing them to benefit from the power of compounding.

Risks of Investing in Dividend Yield Mutual Funds

While a dividend yield mutual fund offers several benefits, it also comes with certain risks:

Market Exposure Risk: Since these funds primarily invest in equity and equity-related securities, they carry a high risk profile. This is due to the inherent volatility of the stock market, where equity investments are subject to market fluctuations and economic changes. As a result, the fund's value can experience significant swings in the short term, impacting the returns for investors who may not be prepared for such volatility.

Dividend Cuts: If a company experiences financial difficulties or market conditions change, it may reduce or stop paying dividends, which can impact the fund's income potential.

Who Should Invest in Dividend Yield Mutual Funds?

Dividend yield mutual funds are best suited for investors who are looking for a balance between income generation and potential capital appreciation. These funds are ideal for:

Income-Seeking Investors: Individuals looking for regular income, such as retirees, may find these funds appealing due to their consistent dividend payouts.

Investors with Moderate Risk Appetite: Investors who prefer less volatility compared to aggressive growth funds but still want exposure to equities might consider these funds.

Long-Term Investors: These funds are suitable for those with a long-term investment horizon, as they offer the benefits of both dividend income and capital appreciation over time.

Investors Seeking Stability: As these funds invest in well-established, dividend-paying companies, they offer relative stability compared to more aggressive equity funds.

Taxation of Dividend Yield Funds

Dividend yield funds have specific tax rules for dividends and capital gains. Understanding these can help you manage your tax liabilities effectively. Here's a breakdown:

Tax on Dividends

Direct Equity Dividends: Dividends received from dividend yield funds are taxed in the hands of shareholders. This means that the dividend gain is added to your entire income and then taxed based on the prevailing income tax rates.

Dividends in Mutual Funds: Dividends received from mutual fund investments at the scheme level are tax-free for the investor as long as they are re-invested into the same fund.

Tax on Capital Gains

Short-Term Capital Gains (STCG): If mutual fund units are sold before 12 months of holding, the profits are considered short-term capital gains. These are taxed at flat 20%.

Long-Term Capital Gains (LTCG): For units held longer than 12 months, the gains are treated as long-term capital gains. These are taxed at 12.5%.

These mutual fund taxation rules are crucial for individuals investing in dividend yield funds as they influence the net returns from these investments.

How to Invest in Dividend Yield Funds

You can invest directly in dividend yield mutual funds through the asset management company's website, or you can use INDmoney to invest online in the best dividend mutual funds in a few easy steps:

• Open the INDmoney app and log in with your credentials.
• Go to the "Mutual Funds" section within the app.
• Use the filter options to select "Dividend Yield Mutual Funds" to see the available options.
• Choose between a lump sum investment or a Systematic Investment Plan (SIP) for ongoing investments.
• Enter the amount you wish to invest and confirm the transaction.