Dividends are an important aspect of investing equity or equity-related instruments. Many companies share a portion of their profits with their shareholders by declaring dividends. Some companies pay high dividends while some others don’t declare dividends at all. It is not mandatory for companies to offer dividends companies choose to declare them to make investing in their stocks more attractive. Here, we are going to talk about Dividend Yield Mutual Funds and explore some salient features and factors that you need to know about them.
In this article
What are Dividend Yield Mutual Funds?
Dividend Yield is the dividend paid per unit divided by the market price. Dividend Yield Mutual Funds are equity funds which invest in equity and equity-related instruments of companies which are known to declare high dividends. Further, a company can declare high dividends only if it makes good profits. Therefore, most of these stocks belong to profit-making companies with an excellent track record.
Typically, a dividend yield fund invests around 70-80% of its corpus in stocks which have a dividend yield higher than that of the market (or benchmark). Hence, it acts as a filter to help the fund manager in selecting stocks. Companies which pay good dividends usually have great cash flows and are more stable than most other stocks.
It is important to note here that the criterion is not merely high dividends but a high dividend yield. This means that if a stock pays good dividends but it’s market price is very high, then the dividend yield is low and the fund might not invest in it. Apart from the dividend yield, the fund managers also look at growth prospects and other fundamentals before investing.
Dividend Option vs. Dividend Yield Fund
It is important that you do not confuse a Dividend Yield Fund with the dividend option of a mutual fund.
Most mutual funds offer two options to investors for receiving returns –
- Growth Option – where the value of your holdings increases when the fund makes profits by selling its holdings
- Dividend Option – where you receive these profits as regular dividend payouts from the mutual fund
A dividend yield fund targets specific stocks and investments and as dividend payout from the companies as its core theme. It is also available in growth and dividend options.
Who should invest in a Dividend Yield Mutual Fund?
Dividend Yield Funds are equity schemes which focus on the dividend yield of stocks. Since these companies are generally stable, it is recommended for investors who want to invest in equity but are looking for lower volatility. While these are not recommended for the aggressive growth-seekers, dividend yield funds are a good addition to most investment portfolios.
Factors to consider before investing in Dividend Yield Funds
We always recommend investors to look at the past performance of the fund before investing. Additionally, here are some factors that you can consider before investing in Dividend Yield Funds in India:
Invest according to your Risk Tolerance
Let’s say that you are a conservative investor who prefers the dividend yield fund to add stability to your portfolio. Hence, you must look for funds which have a higher allocation to large-cap stocks since your objective is investing in a scheme which has low-risk. However, if you invest in a scheme with a higher concentration of small-cap stocks or mid-cap stocks, then your purpose of investing will be defeated.
Tenure of the fund
Like most other mutual funds, it is important to look at the period for which the fund has been in existence. A dividend yield fund which has seen bull and bear phases of the market is in a better position to offer stable returns as compared to the relatively new one. Also, newly launched funds might show a good performance if the markets have been high. Ensure that you consider the tenure of the fund and look at the performance across various market cycles.
Avoid Small Corpus Funds
Many experts recommend that while investing in a dividend yield fund, investors must avoid schemes with a small size of the corpus. This is because a right investment strategy can make the fund look like the best as compared to others and even a couple of mistakes can plunge it to the bottom of the performance table. Look for funds with a reasonable corpus size, low expense ratio, and low volatility in the past.