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What are Dividend Yield Funds?

Created on 04 Dec 2020

Wraps up in 5 Min

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Updated on 12 Sep 2022

The term dividend holds a major significance for someone who is even slightly involved in the trading and finance world. As important as the other aspects of the financial world are, dividends are a critical aspect of any investor’s financial planning.

Dividend refers to a reward or cash that a company provides to its shareholders. It is usually a fraction of the profit that the company shares with its shareholders. It can be issued in numerous forms, like cash payment, stocks, etc.

While making any investment, every investor is majorly concerned about how much returns they will get or the amount of dividend their stocks can yield. Useful tips are expected from every investment instrument, including the investment instrument, which is considered the safest and gives the highest returns, which is mutual funds.

This attraction towards earning dividends has led to the creation of another category of mutual funds, which is known as the dividend yield mutual funds.

So, what are dividend yield funds?

Dividend Yield Mutual Funds

The dividend yield is the dividend paid per unit that is divided by the market price. Dividend Yield Funds are equity funds that invest in equity and equity-related tools of companies known to declare high dividends for their shareholders.

It is important to remember that a company would declare high dividends for its shareholders only to make good profits. Thus, most such stocks pertain to profit-making companies that have a history of excellent records. 

Commonly, around 70-80% of a dividend yield fund’s corpus is invested into stocks that possess a dividend yield higher than that of the market (or the benchmark). Therefore, it acts as a filter to help the fund manager in selecting the stocks. Those companies that generally pay good dividends have significant cash flows and are more stable than most other stocks. 

Who should invest?

Equity schemes that focus on the dividend yield of stocks are Dividend Yield Funds. As these companies are generally stable, it is best suited for investors who want to invest in equity but are looking for lower fluctuations and more stability. 

The dividend yield funds are undoubtedly an excellent addition to most investment portfolios; however, they are not recommended for investors who seek aggressive growth.

Factors to be considered while investing in Dividend Yield Funds

Enumerated below is the list of factors to be considered before trying hands in the Dividend Yield Funds. But above all that, it is always advisable to have a decent knowledge of the fund's past performances. 

1. Avoid small corpus funds

A tip that you would hear from almost all experts in the finance world is that while investing in a dividend yield fund, the investors must avoid schemes that come with a small size of the corpus. 

The reason for this is that the right investment strategy could make the fund look the nicest as compared to others, and even a bunch of mistakes can make it stoop to the bottom of the performance table. It is advisable to search for those funds that come up with an acceptable corpus size, low expense ratio, and low volatility in the past.

2. Consider your risk tolerance

If you are a conservative investor and prefer the dividend yield fund to add stability and peace to your portfolio, you should look for that category of funds with a higher allocation to large-cap stocks; since your purpose is investing in a scheme that has a low risk.

However, if you invest in a scheme that has a higher concentration of small-cap stocks or mid-cap stocks, then, in that case, your purpose of financing will be vetoed.

3. Period of the fund

Like other mutual funds, it is crucial to look at the tenure period for which the fund has existed. It has always been said that a dividend yield fund that has seen both bull and bear phases of the market is in a nicer or better position to offer stable and safe returns than a relatively new one. 

Also, funds might show a good performance if they are newly launched and if markets have been high. Ensure that you consider the fund's tenure and look at its performance across various cycles of the market. 

4.  Taxation

A Dividend Distribution Tax (DDT) of 10% (currently at 7.5% till March 2021, owing to COVID-19) is implied on the dividends paid by equity mutual funds. However, at the time of paying the dividend, this tax is deducted from the total dividend that the investor will receive. Additionally, this amount will also be added to the investor's taxable income.

It is important to note that all the above-mentioned taxes are applicable only on dividend incomes of more than Rs 5000.

When it comes to non-equity funds such as money market, liquid, or debt funds, the Dividend Distribution Tax is 25%. Though the dividends are tax-free on the non-equity funds, in the hands of investors, they become tax-inefficient at a very high rate of taxation.

Dividend Option vs. Dividend Yield Fund

Most people often get confused between the two similar-looking terms, dividend yield and dividend options of a mutual fund; when in reality, the two times are quite distinct.

Most mutual funds offer two options to their investors for receiving returns. These are:-  

  1. Growth Option – It is where the value of your holdings increases when the fund gives rise to profits by selling out its holdings. 

  2. Dividend Option – It is where you earn these profits as regular dividend payouts from the mutual funds. 

A dividend yield fund looks out for particular stocks and investments, with its primary target being the dividend payout from companies. It is also available in growth and dividend options. 

Conclusion

The world of finance is like a pool of knowledge, where each day, each moment, you come across new things to learn. The dividend yield fund is nothing but a small drop of this massive pool. 

These equity-related tools such as dividend yield funds, have great potential to help you earn high returns. It is a type of equity fund where investment is made only in those companies' stocks that declares dividends regularly.

So, if you are planning to invest in dividend yield funds, the major things to keep in consideration are the decent corpus size, low expense ratio, and low historical volatility of the fund. 

All in all, for any investing activity, it is always advisable to come to a conclusion only after thorough research and analysis. So, the investment choice, in the end, should always be yours.

Happy (and smart) investing!!

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Shristi Jain

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Shristi is the Yuvraj Singh of the Finology team. There is absolutely nothing that she cannot do. From beating the bests in table tennis to starting random Twitter spaces for product teams, she has got everyone's back! While she is a great mother to Finology Ticker, she also likes to write sometimes. As a side job, she likes to roast people. 

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