If you are looking to invest in dividend stocks but don’t have the time to research good companies, you can consider investing in dividend yield mutual funds. These are professionally managed funds that give consistent dividends.
In this article, let’s dive deeper into what dividend Yield Mutual Funds are.
What are Dividend Yield Mutual Funds?
Mutual funds that invest in dividend-paying companies are known as dividend yield funds.
These funds seek to offer investors consistent income through dividends received from the businesses they invest in. Dividend yield is calculated by dividing the annual dividend payment by the stock price. The average dividend yield of all the businesses in the mutual fund's portfolio determines its yield.
Dividend yield mutual funds can invest in businesses of various sectors, such as technology, healthcare, financial services, and consumer products. They pick stocks depending on the investment strategy of the fund.
Dividend Option vs Dividend Yield Fund
While both dividend options and dividend yield mutual funds may sound similar, they are two different investment options available to investors in India. Let's understand each one of them in detail:
Dividend Option:
A dividend option is a feature offered by mutual funds, which allows investors to receive a portion of the fund's profits as regular payouts. Investors who opt for the dividend option can receive regular payouts in the form of dividends, which are paid out of the fund's Net Asset Value (NAV). The frequency and amount of payouts depend on the fund's performance and the discretion of the fund manager.
Dividend Yield Fund:
A dividend yield fund is a type of mutual fund that invests in stocks of companies that have a history of paying high dividends. The objective of such funds is to generate regular income for investors in the form of dividends. These funds invest in companies that have a consistent track record of paying dividends and have a strong financial position.
Now, let's compare the two options:
Objective:
The objective of the dividend option is to provide regular payouts to investors from the fund's profits, while the objective of a dividend yield mutual fund is to generate regular income for investors by investing in stocks of companies that pay high dividends.
Payouts:
In the case of the dividend option, payouts are made regularly to investors, while in the case of a dividend yield fund, payouts are made in the form of dividends declared by the underlying companies.
Taxation:
Before April 2020, investors in dividend plans did not have to pay tax on the dividends they received as fund houses would pay a Dividend Distribution Tax (DDT) to the government on their behalf. This tax was deducted from the dividend amount before it was distributed to the investors.
However, the rules changed in April 2020, and now Tax Deducted at Source (TDS) is applied instead of DDT. Under the new rules, dividends received up to Rs. 10 lakh in a financial year are exempt from tax, while dividends exceeding this limit are subject to a tax of 10% on the total earnings.Risk:
Dividend yield funds are subject to market risks as they invest in equity stocks.
On top of everything, investors should evaluate their investment objectives, risk appetite, and tax implications before making a decision.
Who Should Invest in Dividend Yield Funds?
Dividend yield mutual funds are suitable for investors who are seeking a regular income from their investments and are willing to take a little amount of risk to earn higher returns. Here are some types of investors who can consider investing in dividend yield funds in India:
Retirees or those nearing retirement:
Dividend yield funds can be a good option for retirees or those nearing retirement as they provide a regular income stream. These funds invest in stocks of companies with a good track record of paying dividends. However, retirees only with a certain risk tolerance should consider dividend yield funds.
Investors with moderate to low-risk tolerance:
Dividend yield funds can be a good option for investors who are looking for a relatively safe investment option with potentially higher returns than fixed deposits or bonds.
Long-term investors:
Dividend yield funds can be a good option for long-term investors who are willing to stay invested for 5 to 10 years or more. These funds invest in high-quality companies that have a long history of paying dividends and can provide steady returns over the long term.
Investors seeking tax-efficient returns:
Dividend yield funds can be a tax-efficient investment option for investors seeking regular income.
Factors to consider before investing in Dividend Yield Funds
Investing in dividend yield funds in India can be a good way to generate regular income and capital appreciation. However, before investing in such funds, there are several factors that you must consider:
Fund performance:
Before investing in any dividend yield fund, you should evaluate its past performance. Look at the fund's returns over the past 1, 3, and 5 years, and compare them with its benchmark index and peers. Evaluate the consistency of the fund's performance over time.
Fund manager's experience:
The experience and track record of the fund manager is crucial in determining the performance of a dividend yield fund. Look for a fund manager who has a proven track record of managing dividend yield funds.
Investment strategy:
Different dividend yield funds may follow different investment strategies. Understand the fund's investment strategy and make sure it aligns with your investment goals.
Expense ratio:
The expense ratio of a fund can impact its returns. Look for a fund with a low expense ratio, as this can help maximise your returns.
Tax implications:
Dividend income is taxable in India, and dividend yield funds are no exception. Consider the tax implications of investing in such funds before making a decision.
Risk profile:
All investments carry some level of risk. Understand the risk profile of the fund and make sure it aligns with your risk appetite.
By considering these factors, you can make an informed decision when investing in dividend yield funds in India.
Risks associated with Dividend Yield Mutual Funds
For investors searching for a consistent source of income, dividend yield mutual funds can be an excellent alternative. They do, however, come with some risks, just like any other investment. The following are some risks related to dividend yield mutual funds:
Market risk-
Mutual funds that invest in dividend yield companies are exposed to market risk. These funds' value may change as a result of several variables, including the economy, interest rates, inflation, and geopolitical developments.
Sector risk-
Mutual funds with dividend yields may invest in specialised industries like technology, healthcare, or energy. Investing in a particular industry might be dangerous because any unfavourable changes there could lower the value of the fund.
Dividend cut risk-
Dividend yield mutual funds invest in companies that pay dividends. A change in the company's financial performance, however, always carries the possibility that dividends will be reduced. The fund's value could therefore decline, which would lower investment return.
Interest rate risk-
Dividend yield mutual funds invest in companies that pay dividends. But, if interest rates increase, investors might switch to fixed-income investments that provide better yields, which might cause the value of the fund to decrease.
Management risk-
The fund manager's skills and expertise determine how well dividend yield mutual funds perform. If the fund manager makes a wrong or poor investment decision, it will lead to a decrease in the value of the mutual fund.
Liquidity risk-
If dividend yield mutual funds invest in smaller or more illiquid equities, such as small- or mid-cap firms, finding buyers for these equities if the fund manager wishes to sell them can be challenging. Hence there is an element of liquidity risk.
Conclusion
Dividend yield mutual funds can be a good option for investors seeking regular income and diversification benefits. These funds make investments in companies that distribute dividends, giving shareholders a source of income.
Investors should be aware of these funds' risks, though, including the possibility of lower or no dividend payouts as well as greater costs. When investing in a dividend yield mutual fund, it is crucial to thoroughly analyse the investment objectives and risks. Now that you have learned about dividend yield mutual funds, open a Demat account with Angel One and Build your wealth.
Disclaimer: It is important to note that dividend yield funds carry some degree of risk, and investors should carefully evaluate their investment goals and risk tolerance before investing in them. Investors should also consult with a financial advisor before making any investment decisions.
