A dividend is a part of the profit which the company shares with its shareholders. These mutual funds are open ended funds that invest in shares/stocks of companies that pay high dividends. However, a company can pay dividends only if it makes good profits, and therefore, most of these companies have a good track record of profit-making.
As per SEBI guidelines, a dividend yield fund must invest a minimum of 65% of its assets in dividend-yielding stocks. Thus, this acts as a filter for fund managers while selecting stocks. They select companies that can afford to pay high dividends with a proven track record. Besides this, the fund manager also looks for growth prospects and other fundamentals before investing. Investors looking for regular income, even if it is low, should consider investing in these funds.
Dividend yield funds are of two types –
The equity-oriented dividend fund predominantly invests 65% of its assets in equity and equity related instruments of companies that offer high dividends.
Another is the debt oriented dividend fund that predominantly invests 65% of its assets in debt instruments like bonds, money market instruments, etc.
Benefits of Investing in Dividend Yield Funds
Investing in this fund ensures steady cash flows to its investors in the form of regular dividend income. Thus, these funds aim to deliver a stream of high dividends to its investors.
These funds are generally less risky in comparison to other types of equity funds. Also, investment in these funds may help investors minimise their market volatility risk as they can act as a hedge against market uncertainty.
Investment in these funds can provide good returns in the long run. The fund managers prefer bluechip stocks in the fund portfolio because these companies have a historically excellent financial track record. Thus, a stream of continuous dividends indicates that the company is a mature one and is performing well.
Who can Invest in Dividend Yield Mutual Funds?
Dividend yield funds are suitable for investors who are looking to earn regular income from their investments. The dividend from these mutual funds may not be very significant, but they cannot be ignored. Also, dividend payout cannot be guaranteed and same each time. It is entirely dependent on the performance of the underlying companies and market movements.
Investors with low-risk tolerance levels can prefer to invest in dividend yield funds. These investors look for stable returns. Also, during the bear market phase, the underlying companies of this fund can provide some dividend payout. Moreover, for retired investors, this fund can act as an income tool. Besides this, it helps investors to diversify their portfolios.
Things to Consider before Investing in Dividend Yield Funds
The following are the things that the investor must consider before investing in a dividend yield fund.
Past Performance: Studying the past performance of this fund is an essential factor. This helps investors analyse how well the fund manager has managed the fund’s investment objective in delivering returns and consistent dividend payouts. Besides this, investors must also study the fund’s portfolio stocks and asset allocation to make an informed decision.
Investment Horizon: These mutual funds are suitable for investors who are looking for regular income through dividend payouts. Therefore, fund managers select stocks of high quality and consistent track records for paying dividends. So even on the short term horizon, these funds can generate returns as they primarily invest in bluechip stocks.
Investment Objective of the Investor: The objective of the fund is to pay dividends to its investors. The dividend received is helpful for regular expenses or inevitable expenses incurred. However, dividends are not guaranteed and fixed. It depends on the performance of the underlying stock. Therefore, investors investing in dividend yield funds cannot wholly rely on dividends for regular income. They should also have an alternative due to its inconsistency.
Expense ratio: Like other mutual fund categories, dividend yield funds also charge a fee for managing investors’ money. This fee charged is called an expense ratio. If the fund manager changes the portfolio quite often, it might result in higher transaction costs, resulting in a higher turnover ratio. Therefore, investors must look at this factor before choosing a dividend fund as it might impact the fund performance.
Fund Objective: The dividend yield fund investing strategy aims to create capital appreciation along with consistent dividends. Also, the fund managers invest primarily in large-cap companies as the objective of the scheme is low risk. Thus, this fund can be suitable for investors with a low-risk tolerance level. Moreover, the investor’s investment objective should align with the fund objective to help them achieve their financial goals in the long run.
Risk: Mutual funds investments are subject to market risks. Dividend yield mutual funds also face risks depending on the market conditions. Thus, a fund manager plays a crucial role in managing the fund asset allocation to maintain stability in a dynamic market. Investors must select funds with higher asset allocation in large-cap stocks, as a higher concentration in mid and small-cap stocks make the fund volatile.
Besides the above parameters, investors should also consider the Sharpe ratio, Treynor’s ratio, standard deviation, alpha, beta, etc. Some investors lack time and knowledge to do their research. Thus, they can always consult a financial advisor to guide them in their investments. Financial advisors are experts to help investors plan their investments adequately based on their financial objectives.
To sum up, dividend yield funds can be a good way for capital appreciation and earning dividends in the investment portfolio. While investing in these funds, it is crucial to consider the fund size and historical performance. Investors should avoid making decisions on recent or current performance. Also, diversification plays a vital role in building a portfolio, and investors must make intelligent decisions to create wealth for their future.