A comprehensive guide to dividend yield mutual funds in 2024

Dividend Yield mutual funds are a promising investment avenue for those seeking steady income from their investment portfolios. They predominantly invest in equities to get you consistent and high returns.

But,

• What exactly are dividend yield mutual funds?
• How to invest in dividend yield mutual funds?
• What are the taxation aspects of dividend yield funds?
• What are the benefits and limitations, if any, of these funds?

Let us find out.

Understanding dividend yield mutual funds

Dividend yield mutual funds are mutual funds that invest in equities or equity-associated instruments of companies that distribute high dividend yields. They primarily invest in those companies that have a record of increasing or stable dividend payouts.

Dividends refer to that portion of a company’s earnings that is distributed to its shareholders. Dividend yield refers to the ratio of annual dividends per share and the current share price.

According to SEBI, dividend yield mutual funds are defined as funds that allocate a minimum of 65% of their portfolio to equity and equity-related instruments.

The main objective of these funds is to invest in those stocks that pay regular dividends to their investors rather than capital appreciation.

Mostly, a dividend yield fund allocates 70-80% of its assets to equities with a dividend yield surpassing the market average or its benchmark index. Generally, the SENSEX or Nifty 50 is taken as the benchmark index.

In addition to dividend yield, factors such as growth potential and fundamental company health are considered in the investment decision-making process.

Examples of dividend yield funds:

• SBI Dividend Yield Fund Direct Growth
• ICICI Prudential Dividend Yield Fund Direct Growth
• HDFC Dividend Yield Fund Direct Growth
• TATA Dividend Yield Fund Direct Growth

What are the notable features of a dividend yield funds?

Now let us look at some of the notable features of a dividend yield funds:

• They invest a significant portion of their funds in stocks that regularly pay above-average dividends.
• SEBI mandates these schemes to allocate at least 65% of their assets to dividend-yielding stocks.
• These mutual funds mostly invest in companies that distribute a large portion of their profits to investors. Generally, these are government-owned or private-sector firms that regularly pay high dividends to their shareholders.
• Such companies can choose to reinvest yearly profits or distribute them among stakeholders.
• Dividends are paid solely from the profits earned by the mutual fund from its holdings.

Who should invest in dividend yield mutual funds?

1. Low-risk investments

These funds are suitable for investors with a low-risk appetite as they invest in financially sound companies with good prospects of growth.

2. Steady income

Dividend yield funds are also ideal for investors who are looking for a steady stream of income. This is because they primarily invest in high dividend yield companies.

3. First-time investors

Dividend yield mutual funds are ideal for first-time investors as they are low in risk. This makes them suitable for those new to investing.

4. Diversification

Investing in these funds can be a good strategy to diversify portfolio risk as they are low-risk investment avenues.

Understanding dividend yield mutual funds taxation

Now, let us understand the dividend yield mutual funds taxation aspects:

1. Taxation of Dividends: Dividends are taxed at the individual investor’s income tax slab rate.
2. Long-Term Capital Gains: Capital gains from the sale of units held for more than one year are classified as long-term capital gains(LTCG). LTCG is taxed at 10%.
3. Short-Term Capital Gains: Profits earned from the sale of units that were held for less than one year are termed short-term capital gains(STCG). STCG is taxed at 20%.

Advantages and limitations of dividend yield mutual funds

Now let us look at the pros and cons of investing in dividend-yield mutual funds:

Advantages of dividend yield funds

1.  Stable Income Source 

These funds can pay consistent dividends. So there is a consistent income stream that you can build for yourself by investing in these funds.

2. Good returns in the long run 

Since these funds primarily focus on investing in high-growth companies, they have the potential to generate high returns in the long run.

3. Low Volatility 

Volatility in markets generally does not impact these funds as they primarily invest in the equity of companies with good growth potential and strong fundamentals.

Limitations of dividend yield funds

1. Opportunity cost 

Dividend yield mutual funds have their focus on generating a steady income. So, as compared to growth-oriented funds they lose out on the benefits of capital appreciation.

2. No guarantee of dividends 

Despite the name and the focus of the fund on investing in high dividend-yield equities, there is no guarantee of dividends. Companies may skip payment of dividends in case of lower profits or if they reinvest their profits in the growth of the company.

3. Not suitable for everyone 

These are not suitable for all investors as their net asset value(NAV) does not see high growth. So investors seeking capital appreciation might not prefer these funds.

How to invest in dividend yield mutual funds?

Now, we are aware of the features of a dividend yield funds. The next question that arises is how to invest in dividend yield mutual funds.

There are 2 ways you can invest in a dividend yield mutual funds:

1. Online- You can visit the website portal of the respective mutual fund or the intermediary if you are planning to invest through one.
2. Offline- You can visit the nearest branch office of the mutual fund company or your desired intermediary.

Conclusion

Dividend yield mutual funds invest in equities of companies that distribute high dividend yields. They are suitable for investors with low-risk appetite and those seeking stable income. 

As far as dividend yield mutual funds taxation is concerned, dividends from these funds are taxed at individual investor’s income tax rates. LTCG is taxed at 10% and STCG at 20%. But, keep in mind that despite their name there is no guarantee of payment of dividends. To learn more, read StockGro blogs. 

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