What are Dividend Yield Funds: Features, Advantages, Taxation

Understanding Dividend Yield Funds

Certain mutual funds offer high returns to their investors in the form of dividends yielded by the shares. These funds invest only in corporations that have significantly high dividend yielding stocks, thereby enabling the fund managers to extract the maximum value out of their investments.

Features

• Dividend yield funds are known to invest a major part of their corpus in dividend yielding stocks, implying that the companies with these stocks pay an above-average dividend regularly
• Owing to the guidelines laid down by SEBI, these schemes must invest a minimum of 65% of their assets in dividend yielding stocks
• Dividend yield mutual funds are known to invest specifically in those companies that distribute a large part of their profits amongst their investors. Usually, these are government-owned and some private-sector companies which regularly payback to the stakeholders in the form of a high dividend to maximize the shareholders’ value
• These companies have the option to either reinvest the net profit of the year or to distribute that profit among the stakeholders
• These dividends can only be paid from the profits booked by a mutual fund from its holdings

Types of Dividend Yielding Mutual Funds

Dividend yielding mutual funds can be classified into 2 categories based on the asset allocation, returns generated and taxation which are as follows:

1. Dividend Yielding Mutual Funds (Equity)– If a dividend mutual fund allocates a larger portion of its assets (more than 65%) in equity class, it will be classified as Dividend Yielding Mutual Funds (Equity). Equity dividend yielding mutual funds are considered highly volatile in nature.
2. Dividend Yielding Mutual Funds (Debt)– If a dividend mutual has more than 65% of its assets allocated to debts in the investment portfolio, it will be known as Dividend Yielding Mutual Funds (Debt). Unlike equity dividend yielding mutual funds, these funds are much more regular and less volatile in nature.The dividend in these funds is paid from the income of debt funds that comes from the trading of bonds in the market or earning interest on bond/debt holdings.

Dividend Reinvestment and Dividend Sweep

Mutual Funds also offer dividend reinvestment and dividend sweep plans. Dividend reinvestment plans put back the dividend declared into the same mutual fund scheme.

For example-

Let’s assume that Axis Bluechip Fund (Dividend Plan) declares a dividend of Rs. 5 per unit and you hold 100 units of the fund. In case, you are invested in a dividend reinvestment plan, the same amount of Rs. 500 (total value of your funds; 5*100) will automatically and immediately be used to buy more units of Axis Bluechip Fund.

However, in a dividend sweep plan, Rs. 500 will be used to buy units of another mutual fund scheme of Axis AMC (for instance; the AMC is chosen by the investor).

It must be noted that the options of dividend reinvestment and dividend sweep are extremely tax-inefficient. This is because the tax is deducted every time the dividend is paid and reinvested/swept back. As against this, the growth option of a mutual fund will also reinvest the same money in the same fund. However, no tax will be incurred in this reinvestment and hence, its NAV will increase at a relatively faster pace.

Advantages of Investing in Dividend Mutual Funds

• A stream of high dividends can indicate steady cash-flows in the form of regular dividend income
• Dividends are tax-free at the hands of the investor, offering a high tax-exemption threshold
• Dividend funds help minimize the market volatility risk and act as a hedge against market turmoil
• Since these funds are always associated with organizations that have proven records, these funds are always assured of high returns in the future
• These funds provide a significantly better yield on investments in the long run as the fund managers only include bluechip stocks in the portfolio, which have historically excellent financial track records
• The investments made in dividend yield funds involves a marginal level of risk, which makes it suitable for investors with any investment horizon and risk appetite

Who should Invest

• Low risk appetite– Dividend yield mutual funds are meant primarily for investors who are risk-averse and prefer to let go of better profits, rather than exposing themselves to the market risks
• First-time investors– If you are a first-time investor, you may definitely consider investing in this fund as these funds are designed to act as minimal risk-investment routes for limited periods
• Diversified Portfolio– The fund enables an all-round investment and risk assessment on a large scale, thereby assisting the potential investor in owning a diversified portfolio
• Short investment horizon– Investors who cannot wait for long time periods in order to gain from the returns generated on their investments may consider this fund, as it tends to deliver high returns even in a short time frame
• Regular income– Investors who are looking for a regular income, even if comparatively low, but regular should consider investing in these funds

Points to be Considered

• A high dividend payout may indicate that the company does not have enough growth opportunities
• Dividends attract Dividend Distribution Tax (DDT) paid by the company at the time of declaring dividends. Hence, although the dividend is tax-free in the investor’s hands, the same is paid to him after deducting tax
• Dividends are not guaranteed and depend on the profits made by the company. Hence, they cannot be absolutely relied upon for a fixed amount
• Dividend funds are likely to underperform the growth funds in a bullish market trend
• Before making any investments in these stocks, investors must check the fund’s consistent dividend payout and consistent growth in the dividend paid by the fund. These factors define how the fund has been performing in the past and what will be its performance in the future

Taxation

Fund Type	DDT Rate	Effective DDT Rate (inclusive of CESS)
Dividend Mutual Funds (Equity)	10%	11.64%
Dividend Mutual Funds (Debt)	25%	29.12%

Dividends paid by equity mutual funds are subject to a dividend distribution tax (DDT) of 10%. However, this tax is deducted at the time of paying a dividend and hence, the dividend is tax-free in the hands of the investor.

Dividend distribution tax on non-equity funds such as money market, liquid, debt funds is 25%. Though dividends on non-equity funds are tax-free at the hands of investors, a very high rate of taxation makes them tax-inefficient.

Best Dividend Yield Funds to Invest in 2020

Fund Name	AUM (Cr)	1-year Returns (%)	3-year Returns (%)	5-year Returns(%)
Principal Dividend Yield Fund	183	10.85	13.20	9.07
Templeton India Equity Income Fund	909	8.53	9.51	7.35
UTI Dividend Yield Fund	2,346	7.85	10.30	6.46
ICICI Prudential Dividend Yield Fund	171	3.10	6.53	5.36
Aditya Birla Sun Life Dividend Yield Fund	753	10.79	5.41	3.46

Data as on 24 January 2020; Source: Value Research

The above list has been created basis the 5 year returns generated by these funds

Related article: Best Dividend Yield Funds to Invest in 2020

How to Invest in Dividend Yield Funds

You can invest in dividend yield funds through either of the following ways-

• Offline mode of investing– If you are not confident of your knowledge, you may choose to invest through a broker. However, investing in a fund through a broker will make you eligible for investments through regular plans that offer different returns and varied expenses in investment. If you wish to invest in the fund independently, you must visit the nearest branch of the AMC of your fund. Don’t forget to carry the following documents-
  • Identity Proof (Aadhar Card)
  • Canceled cheque
  • Passport size photos (around 4-5)
  • PAN Card
  • KYC documents (for KYC verification)

Online mode of investing– If you do not wish to add on to your expense of commissions or brokerage, you may visit online investment platforms such as Paisabazaar.com wherein you can choose from and compare more than 1,700 funds- all in one place, instead of following the long procedure of visiting the website of each AMC and then choosing from them. Here, you can select the fund in which you want to invest, look at the details and compare similar schemes as well as use SIP Calculator or Lumpsum Calculator to estimate the future value of your investment