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Dividend Yield Funds – What is it, Advantages, Limitations, Taxation, Best Funds

  • Marisha Bhatt
  • Jan 12 2022
  • 9 minutes
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From the very start of investments in stock markets, for many investors, one of the main focuses of investing in stock markets was only to earn dividend income. This was especially true in the case of conservative investors who count on dividend income as an alternate source of income and plan their financial expenses around it. 

This scenario has more or less changed, as dividend income is still the driving force for the investment in equities but the focus is not just on stock markets. There are other investment options as well that provide the benefit of dividends along with many other benefits. Dividend yield funds are among such investments that provide dividends on a relatively regular basis along with other benefits associated with mutual funds. 

Given below are a few details related to dividend yield funds that can help investors make better investment decisions. 

What are dividend yield funds?

Dividend yield funds are mutual funds that invest majorly in companies that have a good track record of providing higher and relatively regular dividends to the investors. The SEBI guidelines state that these funds have to invest at least 65% of the fund in dividend-yielding instruments to be qualified as dividend-yielding funds. 

There are primarily two types of dividend-yielding funds based on their dominant asset class. When the dominant asset class (more than 65%) of the fund is equity and equity-related instruments, they will be considered to be dividend-yield equity funds. Similarly, when the dominant asset class is debt and debt-related instruments, they will be classified as dividend-yield debt funds.

Who are the target investors of dividend yield funds? 

These funds aim at providing more or less a stable source of income to the investors. The amount of dividends and the frequency cannot be guaranteed as it depends on the performance of the fund against market volatility. But as the investment is in primarily financially sound companies having a good track record of providing dividends, the benefits of the fund cannot be ignored. 

These funds are ideal for investors with moderately high-risk appetites who want to invest in the equity market but also want to limit their risk. These funds usually provide good returns even in the short term. Hence these funds can be a very good addition to conservative investors with short-term investment horizons as well as aiming for a regular source of alternate income.

What are the advantages of dividend yield funds?

The primary advantage or attraction of these funds is the potential to earn regular dividends. Besides this, the other advantages of the funds are discussed below.

Diversification

Diversification is the primary benefit of any neutral fund. Under these funds too, investors get the benefit of earning potentially higher returns through an array of investments made across various companies, sectors, industries, asset classes, etc. This eventually helps the investors earn potentially higher returns through their investments in dividend yield funds.

Lower risk 

The risk of these funds is comparatively lower than investing in individual high dividend yield stocks or instruments. The benefit of diversification further helps in mitigating the risks of investing. Most of the dividend-yielding instruments are cash-rich companies having a sound business model and proven track records hence the risk of investments in these underlying instruments is further reduced. 

High yield in the long term

Dividend yield funds are ideal for investors with short-term investment horizons. However, they have the potential to provide higher yield in the long term. This means that these funds are ideal for both categories of investors having a short-term or long-term investment horizon. 

Ideal for new investors

Dividend yield funds have lower risks and more or less regular returns potential. This makes them ideal for new investors having a lower risk appetite and limited experience.  

What are the limitations of dividend yield funds?

Dividend mutual funds also come with their own set of limitations. Some of the limitations are discussed below.

Higher tax

The Union Budget of 2020 has shifted the tax incidence of dividend income in the hands of the investors. This has made the dividend income less attractive especially for investors in higher tax brackets as the dividend income is taxed at the applicable slab rates of the investors. 

Returns dependent on fund performance

These funds are relatively less volatile as the underlying investments of the fund are affected relatively less due to market fluctuations. However, there is no denying the fact that the returns are subject to market risk and are not guaranteed.

Inherent risks of mutual funds

Mutual funds have many inherent risks like market risks, liquidity risks, credit risks, concentration risks, etc. These risks are present in the case of dividend-yield funds too making the investors potentially lose their investment. 

How are dividend yield funds taxed?

The taxation of dividend yield funds is twofold i.e., on account of dividends received from the fund and the capital gains generated at the time of redemption of funds.

Dividends are taxed in the hands of the investors at their applicable slab rates post the amendment in the budget of 2020. 

Capital gains, on the other hand, are based on the type of dividend-yield fund i.e. based on their dominant asset class. The tax structure of these funds is detailed below.

Type of funds Short term gains Tax rate Long term gains Tax rate
Dividend-yield equity funds Less than 12 months 15% (plus cess and surcharge) 12 months and more Exempt up to Rs.1,00,000Above Rs.1,00,000 taxed at 10% (plus cess and surcharge)
Dividend-yield debt funds Less than 36 months Slab rate of investor 36 months and more 20% (plus cess and surcharge)

What are the points to consider while investing in dividend yield funds?

Dividend yield funds as mentioned above are a good addition to any investment portfolio. However, there are certain points to be considered before making the investment decision in these funds which are discussed below.

Investment goals of the investor

Dividend funds are best-suited for investors looking for more or less a steady or regular source of income. Hence, if the goal of the investor is wealth creation then these funds may not meet their requirements.

Fund reputation and the consistency or frequency of payouts

It is advisable to check the fund’s reputation to understand the past record of the frequency of the payouts made by the fund. This will help investors make a better investment decision and avoid funds that have a poor track record in this category. 

Taxation

The taxation of dividends in the hands of the investors has effectively reduced the benefits of dividend income especially for investors belonging to a higher tax bracket. Thus in the current tax scenario, growth funds may prove to be more valuable to such investors as compared to dividend yield funds. 

Fund performance

The returns of the fund are linked to market performance and are not guaranteed or consistent. This fact has to be thoroughly evaluated by the investors before selecting a fund. These funds provide relatively lower returns as compared to growth funds. This is another factor to be considered and compared by investors to make a profitable investment decision. 

Top dividend yield funds

The top funds in this category and their basic details are provided hereunder. 

Principal Dividend Yield Fund Direct growth

This is a fund investing in high dividend-yielding companies and the benchmark of the fund is NIFTY Div Opps 50 TRI. The basic details of the fund are mentioned below.

Particulars Details
Fund manager Mr. Ravi Gopalakrishnan
Launch date 1st January 2013
Minimum SIP investment Rs. 1,000
Expense ratio 2.13%
Risk Very high

The returns provided by the fund as of 5th September 2021 are tabled below

Period 6 months 1 yr 3 yrs 5 yrs Since launch
Returns 19.95% 57.08% 16.44% 17.36% 15.06%

ICICI Pru Dividend Yield Direct Growth

This is a direct plan of dividend yield fund from the fund house of ICICI Prudential Mutual Fund. The fund was launched in 2014 and is categorized as a high-risk fund. The basic details of the fund are mentioned below.

Particulars Details
Fund manager Mr. Mittul Kalawadia
Launch date 16th May 2014
Minimum SIP investment Rs. 1,000
Expense ratio 1.67%
Risk Very high

The returns provided by the fund as of 5th September 2021 are tabled below

Period 6 months 1 yr 3 yrs 5 yrs Since launch
Returns 20.88% 64.93% 12.63% 13.47% 14.17%

Conclusion

Dividend yield funds are a good source of alternate income for new and risk-averse investors. These funds although have market-linked returns, with low volatility of the funds make them an attractive addition to any portfolio. Having said that, it is to be noted that a high dividend-paying company usually implies that the best years of the company are behind them and they have reached maturity in the market. It is, therefore, always prudent to have a balanced portfolio with growth and dividend-oriented funds to maximize the investor’s wealth in the long run. 

FAQs

1. Can the dividends declared by the company be re-invested in the fund?

A. Yes. dividends declared by the company can be reinvested in the fund based on the type of the fund and their guidelines as well as the fund manager’s discretion.

2. Does a high dividend-paying company always indicate a cash-rich company?

A. A high dividend-paying company may not necessarily always be interpreted to be a cash-rich company. Declaring dividends may also be a kind of window dressing exercise to misguide the investors of the true position of the company.

3. What are the pointers for an ideal dividend yield fund?

A. There is no set format or formula to determine the ideal dividend yield fund. However, the funds with a low expense ratio, better track record in dividend payout, better underlying assets, higher corpus fund, and lower volatility have to be favored in this category. 

4. What is a dividend yield?

A. Dividend yield is the amount of dividend paid power unit or per share divided by the market price of such share.

5. How to invest in dividend yield mutual funds through Finity?

A. Finity is an excellent platform to invest in dividend yield mutual funds. The process for the same is detailed below.

  1. Download the Finity App from the google play store
  2. The next step is to login using the valid login credentials 
  3. Select the ‘Equity funds’ category from the home page.
  4. The next step is to select Dividend Yield Funds from the next page
  5. Investors will be given a list of funds under this category. They can click on the fund to get the relevant details before making the investment decision. 
  6. Following this investors will have to select ‘Invest’ which will take them to a new page requiring selection of mode of investment (lumpsum or SIP) and the amount to be invested.
  7. The said amount has to be paid through any of the available payment modes and the fund will be reflected in the portfolio tab of the investor.  
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