Dividend Yield Funds in India - What Is It And How It Works?

Investors have different goals when it comes to investing. While some are eyeing wealth creation, others want a passive income. If you are later, then you should select such instruments that provide regular returns on your investments. Dividend yield funds are one of them. Dividend yield fund managers typically invest in businesses that generate steady cash flows and are able to pay dividends consistently. Moreover, such businesses typically don't cut their payout during a slump. Let’s have an in-depth understanding of mutual fund dividend yield funds.

What are Dividend Yield Funds?

In simple terms, dividend yield funds are those funds that provide returns in the form of a mutual fund dividend to the shareholders. Dividend yield funds are passive income-generating funds ideal for those investors who want a regular inflow of income from their investments. A dividend yield fund places its capital in equities with dividend yields that are higher than the market average.

It is pertinent to note that the equities in which dividend yield funds invest (70% to 80%) are higher than the Sensex or the Nifty 50. The remaining 30-20% of stocks are invested in any profitable avenues without reservations. Compared to their growth-oriented peers, mutual fund dividend yield funds are typically less volatile thanks to the nature of their investments. This is because these companies are usually liquidity rich and have adequate reserves and therefore are more stable than their peers.

However, experts often warn dividend yield funds to underperform in comparison to their growth fund peers in the rising market. Nevertheless, these funds suit conservative investors looking to invest in equity funds.

How Do Dividend Yield Funds Work?

Some companies declare huge dividends, while others do not declare dividends at all. Some companies distribute dividends when they make good profits and want to distribute the same to the shareholders.

While other companies prefer to retain their profits for company operations and expansion. In such cases (when companies prefer to retain their profits), the share value of the company increases, leading to compounding in the future, which is ideally suited for wealth creation.

Dividend yield funds, therefore, invest 70%-80% of the corpus in equity and equity instruments of companies that pay huge dividends. Such companies have good cash flows and are often considered more stable than other companies. Further, what matters here is not high mutual fund dividendsbut a high dividend yield. Let’s understand with a practical example:

Suppose you invest in two dividend-yielding stocks, i.e., stock A and stock B. While stock A provides a dividend of Rs. 100 per share, stock B provides a dividend of Rs. 300 per share. Stock B seems attractive, right? Why not because it gives more dividends than stock A.

However, the tables turn when we come to know their share price. While the price of stock A is Rs. 500, the price of stock B is Rs. 2500. Let’s calculate their dividend yield with a simple formula:

Dividend yield = Dividend per share / current price per share * 100

Stock A = Rs. 100 / 500 * 100 = 20%

Stock B = Rs. 300 / 2500 * 100 = 12%

The dividend yield of stock A is 20%, while the dividend yield of stock B is 12%. Therefore, even though stock B is paying a higher dividend, it is still less when compared to stock A because you can just purchase five stocks of A at Rs. 2500 and earn Rs. 500 as a dividend instead of purchasing one stock of B at Rs. 2500 and earning Rs. 300 as a dividend.

Who Should Invest in Dividend Yield Funds?

Well, here comes the interesting part: who should invest in mutual fund dividend yield funds? If you belong to those categories of investors who want to generate a passive income, then you should go for dividend yield funds. Dividend yield funds provide investors with a regular passive income that helps them meet their costs and expenses.

Benefits of Investing in Dividend Yield Funds

Here comes the ‘why’ part, i.e., why you should invest in dividend yield funds. While it can have many reasons, you should certainly consider the following benefits of investing in dividend yield funds:

· Investors of dividend yield funds receive a regular income from their investments due to high mutual fund dividend payouts from the underlying equity instruments

· Companies paying huge dividends are often stable, and stocks of such companies can sail through volatility and fluctuations easily

· These funds are ideal for beginners for whom return on investment is important to stay motivated and kick-start their investment journey

· The investors of dividend-yielding funds not only get returns in the form of dividends but also receive returns in the form of capital appreciation

Fees and Charges of Dividend Yield Funds

Dividend yield funds, like any other mutual fund, also involve certain fees and charges. Dividend yield funds are actively managed funds, unlike index funds, which are passively managed.

Therefore, dividend yield funds involve a higher charge as compared to their passively managed counterparts. The following are the charges you should keep in mind while investing in dividend yield funds:

• Brokerage charges: These are the charges levied by the stockbroker. It depends upon the terms and conditions of the broker you select
• Expense ratio: The expense ratio is the charge of maintenance and administration of funds. These charges usually vary among different funds, and the expense ratio for passively managed funds (like index funds) is lower than the actively managed funds (dividend yield funds). This is because the actively managed funds also involve higher fund manager fees for actively managing the portfolio. Always check the expense ratio before investing in any fund because it directly reduces your return on investment
• Commissions: If you invest in dividend yield funds through a mutual fund agent or mutual fund distributor, then you ought to know about the commission charges. Mutual fund houses pay the mutual fund agents and distributors certain commissions for selling the mutual fund schemes. These commissions are paid from the returns earned by the mutual fund schemes and, therefore, directly get reduced from your returns. However, if you invest in direct funds, then you can save on commission costs. In the long run, these can significantly increase your returns. For investing in direct funds, you can visit Jupiter Money, which allows you to invest in some of the best direct mutual funds.
• Account opening charges: If you open a Demat account with any stock broker to invest in the dividend yield funds, then you might have to pay account opening charges depending upon the stockbroker.
• Account maintenance charges (AMC): Account maintenance charges are the annual charges that you have to pay to the stock brokers to maintain your account with them.
• Other charges: Other charges can include depository participant charges, STT (basically a tax), entry and exit load, etc.

Working of Dividend Yield Funds

Dividend yield funds pool money from investors and invest the majority of the money in high dividend-paying companies. The remaining portion may be invested in other companies that the fund manager believes has the potential to generate high returns. When these companies release dividends, these dividends are passed on to the investors. Thus, dividend yield funds act as a great source of passive income.

In a Nutshell

If you are looking for an ideal source of passive income, then you can invest in dividend-yielding funds. What makes funds preferable to dividend-yielding stocks is the fact that funds provide the benefit of diversification of the portfolio, which directly reduces the risk of investment. Start your investments now to start your passive income.

Note: this article is not a piece of investment advice. Professional consultation prior to making any significant investment decisions is highly advised.

Frequently Asked Questions

What is the difference between actively managed funds and passively managed funds?

Actively managed funds are those where the funds are managed by a fund manager, whereas passively managed funds just track a specified index or underlying asset.

Is there an exit load on dividend-yielding funds?

An exit load is usually charged when you sell your mutual fund units. The percentage of exit load depends upon the terms of the scheme.

What are the other avenues where mutual fund dividend yield funds invest apart from dividend-yielding equity shares?

Dividend-yielding shares invest 75%-80% of the corpus in dividend-yielding equity and equity-related instruments, whereas the remaining corpus is invested in different high-return generating avenues as decided by the fund manager.