Dividend-paying mutual funds refer to equity-oriented mutual funds that mainly invest in organizations that pay dividends.

Dividends refer to profit that is earned by companies and this profit is shared with the shareholders of the company.

The profit is nothing but the yield that mutual funds get by selling the shares at prices higher than what it was purchased for.

Depending on the scheme, the fund manager can either declare a dividend or use the profit to purchase stocks.

When you choose an equity oriented mutual fund that offers dividends, you can enjoy maximum profitability which will result in excellent growth for your funds.

The Asset Management Company can choose to pay dividends daily, monthly, quarterly or annually. This generally varies from one scheme to another.

Even though most dividend mutual funds strive to pay dividends to investors, it is never guaranteed.

Dividend mutual funds share almost every trait with their counterpart growth mutual funds – the fund manager, allocation, objective, etc.

The key difference though is that they pay dividends to the investors.

These dividends are not fixed.

The frequency and amount of dividend to be paid is left to the discretion of the fund manager. The most common frequencies are monthly and quarterly.

The objective of a dividend fund is nothing but to maximize the dividends for its investors. While all dividend funds strive to achieve this objective in the best possible manner, some of them are more preferred compared to others.

Tax implication is one of the differentiating factors. Equity dividend funds are not taxable under section 10(23D) while the debt dividend funds are taxable. At the same time equity dividend funds will provide you higher returns, however they also carry higher risk with them.

Why Dividend Mutual Funds?

Dividend mutual funds offer regular dividends that are decided by the fund managers. Dividend mutual funds take longer to show the same results that a growth mutual fund does. However, one major advantage dividend mutual funds have is that they start paying back much quicker. People who are greatly dependent on a sum of money and yet want to mobilize it to earn more money can opt for dividend mutual funds. This way, there is some form of capital protection while still getting regular dividends. They invest their money in a dividend mutual fund and live off the dividends instead of directly eating into their savings. This offers a certain peace of mind to the investors. Certain investors would trade peace of mind for higher returns and dividend mutual funds suit them best. Another group among which dividend mutual funds are very popular are new investors. New investors might not have the patience to wait too long for returns. They are easily gratified by the much sooner and regular returns received in the case of dividend funds.

How Do Dividend Mutual Funds Work?

Dividend mutual funds provide investors annualized pay-outs. These pay-outs are made on a regular basis and hence, as an investor, you feel safe to invest in these funds. Also, dividend obtained from mutual funds are tax-free. However, fund houses pay a dividend distribution tax (DDT) of 28.84% for debt funds. This amount is however inclusive of surcharge and cess. On the other hand, the finance minister has introduced 10% tax on equity mutual fund dividends. It was in line with the introduction of 10% on long-term capital gains on equity mutual funds.

Tax on Dividend Yield Mutual Funds

Dividend mutual funds are taxed a bit differently. You do not have to pay any taxes upon receiving your dividend. However, the tax is paid by the mutual fund even before reaching you. In that sense, dividend mutual funds are not very tax efficient. If you require a fixed income and have a large amount of money to invest, you should consider investing using the SWP (Systematic Withdrawal Plan) option.

Conclusion

Many investors are putting money into the dividend option of mutual funds. Cash flows from their investments help manage expenses. Most financial planners recommend dividend option for investors who need a regular stream of cash flow. Those looking to build wealth over the long term through equity mutual funds should opt for the growth option. This is because the compounding benefit is lost when a dividend is paid. Unless the amount is invested immediately in a higher yielding asset. So, dividend mutual funds are ideal for investors who do not have an appetite for risk and who wish to receive regular pay-outs as a source of income. But remember, there are a lot of factors you should look at before selecting a mutual fund scheme that matches your investment goal. Mutual fund investors in India may disagree on strategies and fund choices but one of the few things that most would agree on is the fact that investing for the long-term is an ideal method to maximize potential gains. Hence, analyse your goals and risk appetite and invest accordingly.