Dividend Yield Funds - Advantages and How to Invest (2024)

Dividend yield funds are a type of mutual fund that invests in companies that have a history of paying high dividends. These funds aim to generate income for investors by investing in high-dividend-yielding stocks. As per SEBI, a dividend yield fund must invest minimum 65% of its assets in equity and its associated instruments. In this article, we will discuss the basics of dividend yield funds, their advantages and limitations, and factors to consider before investing in them.

What are dividend yield funds?

Dividend yield mutual fundsare a category ofequity mutual fundsthat invest specifically in stocks of companies that pay out high dividends. These funds focus on stocks that providehigher dividend yieldscompared to the average market level. The portfolio of dividend yield mutual funds includes established blue-chip companies, utilities, and realty firms.

Here are key points about dividend yield funds:

• Purpose: They aim to generate income for investors by investing in high-dividend-yielding stocks.
• Risk profile: These funds are consideredlow-riskcompared to other equity mutual funds.
• Investor suitability: Ideal for investors seekingregular incomefrom their investments.

Remember, dividend yield funds strike a balance between income generation and risk management, making them suitable for those who prioritise stability and passive income.

How does a dividend yield mutual fund work?

A dividend yield mutual fund typically allocates its investments into equities of companies known for their higher dividend payouts. These funds specifically target firms with a history of increasing dividends or offering substantial dividend yields.

Conversely, amutual fund featuring a dividend option may not suit every investor, primarily because its Net Asset Value (NAV) does not experience rapid growth. This scenario arises when dividends are promptly distributed once a specific threshold is met.

Therefore, dividend yield mutual funds are most suitable for investors with a low-risk tolerance who seek regular monthly payouts as a dependable income source.

Dividend option vs dividend yield fund

Dividend option and dividend yield funds represent distinct categories within mutual funds. Mutual funds provide investors with two primary options for receiving returns – growth option and dividend option.
Growth option mutual funds are investment vehicles that focus on capital appreciation over regular income distribution. In these funds, the profits generated are reinvested, leading to an increase in the fund's Net Asset Value (NAV).
Dividend yield funds, on the other hand, invest in companies that have a history of paying high dividends.

Features and benefits of dividend yield mutual funds

Dividend yield fundsare a specialized category ofequity mutual fundsthat focus on investing in stocks of companies known for their consistent dividend payouts. Let us delve into the features and advantages of these funds:

Features of dividend yield mutual funds

• High dividend-yielding stocks
  These funds primarily invest in companies that regularly distribute dividends to their shareholders. The portfolio includes government-owned and private-sector firms committed to maximising shareholder value through dividends.
• Minimum asset allocation requirement
  As per SEBI guidelines, dividend yield funds must allocate at least65% of their assetsin dividend-yielding stocks.
• Profit distribution options
  Companies can either reinvest their net profits or distribute them among stakeholders. Dividends paid by mutual funds are sourced from the profits earned through their holdings.

Advantages of dividend yield mutual funds

• Diversification
  Dividend yield funds invest in a diversified portfolio of stocks, which helps to reduce the risk of investing in a single stock.
• Lower risk
  Dividend yield funds are less risky than other forms of equity mutual funds, which makes them low-risk funds and most suitable for investors who have a low-risk appetite.
• High yield in the long term
  Dividend yield funds aim to generate income for investors by investing in high-dividend-yielding stocks. These funds offer a high yield in the long term.
• Ideal for new investors
  Dividend yield funds are ideal for new investors who are looking for a regular source of income.

Taxation of dividend yield funds

Following the amendments introduced in the Union Budget 2020, dividends distributed by mutual funds are now subject to taxation based on the investor's income tax slab. Additionally, the taxation rate on capital gains generated by these funds relies on the duration of holding and the extent of equity exposure within the fund.

When the equity exposure surpasses 65%, the taxation regulations applicable to equity funds come into effect. Conversely, if the equity exposure falls below this threshold, the taxation rules of debt funds are applied. Hence, it's essential to be aware of the fund's equity exposure before investing, as this enables more effective tax planning strategies.

Who should invest in a dividend yield mutual fund?

Dividend yield mutual funds are ideal for investors who are looking for a regular source of income.These mutual fund schemes are also suitable for investors who want to invest in equity but are looking for lower volatility.

Limitations of dividend yield mutual funds

While they carry several advantages, dividend yield funds are not immune to inherent risks. Here are some of their limitations:

• Limited Capital Appreciation
  Dividend yield mutual funds primarily focus on income generation, potentially limiting their capital appreciation compared to growth-oriented funds. Investors seeking substantial capital gains may find these funds less suitable for their objectives.
  
• Not Suitable for Short-Term Goals
  These funds are typically more suitable for long-term investors seeking regular income. For investors with short-term financial goals, the fluctuation in dividend payouts may not align with their income needs.

Factors to consider before investing in dividend yield funds

Before investing in dividend yield funds, investors should consider these factors:

• Risk tolerance
  Investors should consider their risk tolerance before investing in dividend yield funds. It is suggested to properly understand the market and economic risks and then make your investment choice.
  
• Tenure of the fund
  Investors should look into the duration of the fund’s investment tenure. A dividend yield fund that has seen the stock market’s bull and bear phases will provide a higher return than newer companies.

How to invest individend yield funds through Bajaj Finserv?

Step 1: Click on INVEST NOW. You will be redirected to the mutual funds listing page.
Step 2: Filter by scheme type, risk appetite, returns, etc. In this case ‘Dividend Yield Funds’.
Step 3: All the mutual funds of the particular category will be listed, along with the minimum investment amount, annualised return, and rating.
Step 4: Get started by entering your mobile number and sign in using the OTP.
Step 5: Verify your details using your PAN, date of birth. If your KYC is not complete, then you will have to upload your address proof and record a video.
Step 6: Enter your bank account details.
Step 7: Upload your signature and provide some additional details to continue.
Step 8: Choose and select the mutual fund that you want to invest in.
Step 9: Choose whether you want to invest asSIP or lumpsum and enter the investment amount. Click on ‘Invest Now’.
Step 10: Select your payment mode i.e., net banking, UPI, NEFT/ RTGS.
Step 11: Once your payment is done, the investment will be complete.
Your investment will start reflecting in your portfolio within 2-3 working days.

Conclusion

Dividend yield funds are a type of mutual fund that invests in companies that have a history of paying high dividends. These funds aim to generate income for investors by investing in high-dividend-yielding stocks. Dividend yield funds offer several advantages; however, investors should also consider the limitations of dividend yield funds, before putting in their money.

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