What are Dividend mutual funds?

A dividend yield is simply the dividend paid per unit divided by the market price. Dividend yield mutual funds are a type of equity fund where investment is made in the stocks of companies that regularly pay dividends. As per the regulations of the Securities and Exchange Board of India (SEBI), at least 65% of the portfolio of a dividend yield fund must be invested in dividend-paying securities. However, while investing, keep in mind that organisations pay dividends only when there are profits. 

Dividend mutual funds are also categorised into primarily two categories based on equity exposure. The fund is classed as a dividend-yielding equity fund if it has more than 65% equity exposure. If not, the fund is regarded as a debt fund that pays dividends.

However, it's worth noting that the requirement isn't just a big dividend but also a high dividend yield. This indicates that if a company offers a high dividend yield but has a high market price, the dividend yield is low, and the fund may not invest in it. Before investing, fund managers consider growth possibilities and other elements in addition to the dividend yield.

Dividend mutual funds advantages 

• Since these funds invest in shares of companies with excellent track records, they have the capability to generate better returns in the long term.
• The capability of these funds to declare regular dividends is better considering the track record of the companies, which makes it a perfect option for those seeking steady dividend income and stability.
• These funds are relatively less impacted by market volatility, thereby offering a safer investment than other equity schemes for those looking for higher returns than fixed income instruments like fixed deposits.
• These funds are perfect for beginners with a low-risk appetite.

Who should invest in dividend mutual funds? 

Since the underlying securities in these funds include stocks of financially sound companies with an impressive cash flow, these are best suited for investors looking to invest in equity without getting involved in too much risk. These are the perfect instruments for a relatively steady regular income. First-time equity investors are the perfect ones to invest in dividend yield funds. Irrespective of that, it needs to be kept in mind that the returns are not guaranteed and can fluctuate significantly between bullish and bearish markets.

Taxation on dividend-paying mutual funds

Following the revisions introduced in the Union Budget 2020, the dividends from these dividend-paying mutual fund distributions are now taxed in the hands of investors according to their income tax slab. These funds' capital gains tax rate varies depending on the holding period and the kind of equity exposure. If the equity fund exposure exceeds 65%, the taxation of equity funds regulations apply. Otherwise, the provisions for debt fund taxes apply. Therefore, you must consider your stock exposure before investing so that you can plan your taxes better.

Per the Finance Act of 2020, on or after April 1, 2020, TDS was imposed on dividend distribution by mutual funds. TDS is levied at 10% on dividend income over Rs 5,000 received from a company or mutual fund.

Mutual funds: Growth vs Dividend 

Factors to consider before investing in dividend-paying mutual funds 

One thing you should always do before investing even in the best dividend-paying mutual funds is to look at the past performance of the funds. Apart from that, below are some points you can look out for: 

• Just like any other mutual fund, you should always keep your risk tolerance in mind before investing. 
• The tenure of the fund is another thing to look at. A fund that has seen the highs and lows of market volatility is in a better position than other funds. Ensure that you take a look at the fund’s performance across cycles before investing. 
• Some experts often suggest avoiding funds with a small corpus size. While the right investment strategy can reach great heights, one wrong move can lead to the bottom. Hence, invest wisely and carefully in funds with a low expense ratio, reasonable corpus size, and low volatility in the past. 

FAQ's 

• What is a good dividend yield for a mutual fund?

Anything between 2% to 6% can be considered a good yield, but it depends on many factors.

• Do mutual funds pay dividends?

Mutual fund distributions are divided into categories based on the kind and nature of the dividend. As a result, mutual funds can distribute interest, dividends, and/or capital gains.

• What is the difference between dividend and growth mutual fund?

Profits are reinvested in the scheme for a higher NAV in the case of a growth mutual fund. On the other hand, in the case of a dividend mutual fund, the profits are paid to the investor.

• What is the meaning of dividend-paying mutual funds?

A dividend mutual fund invests mainly in dividend-paying firms. These dividends are mostly earnings/profits distributed among stockholders/shareholders by firms.