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Last Updated : Dec 03, 2019 03:45 PM IST | Source:

Dividend mutual funds: Advantages, types, how it works

Dividend Funds: Everything you need to know about Dividend Mutual Funds, its types, advantages, how it works & how to invest in India. Read more on dividend mutual funds at Moneycontrol.

As an investor, based on investment goals, you can choose to invest in two kinds of mutual fund systems: growth-oriented and dividend-oriented. A growth-oriented mutual fund invests in a potential-showing company's stocks. The main goal of the investment is to achieve maximum capital appreciation.

On the other hand, you can choose to invest in a dividend yield fund. The fund house invests in stocks of businesses paying a large dividend in this situation. These firms produce high earnings that enable dividends to be declared. Investments are therefore made in stocks of businesses that have proven track records of earnings being declared. If you've invested in dividend-oriented funds, you might want to learn about these dividend mutual funds.


Types of Dividend Mutual Funds

Dividend mutual funds can be categorized into two classifications based on asset distribution: Dividend Yielding Mutual Funds (Equity) and Dividend Yielding Mutual Funds (Debt) fund.


In the case of a dividend mutual fund (equity), the fund house invests predominantly in equity stocks of a company. As per the regulations of SEBI, an equity mutual fund scheme must invest at least 65% of the scheme’s assets in equities and equity-related instruments. The chief objective of these funds is to provide capital appreciation over a medium to the long term investment horizon.

In the case of a dividend mutual fund (debt), a mutual fund scheme invests in fixed income instruments, such as bonds issued by the government and corporate, debt securities, and money market instruments, etc.  These mutual funds are a popular investment option for investors who do not have a huge risk appetite but want steady returns. Debt mutual funds are referred to as fixed-income securities as the investor is aware of the returns to be received from the investment right from the time of the investment. These funds are considered less risky than equity funds and offer significant tax benefits.

The above types of dividend mutual funds also vary from each other in terms of yields and tax treatment.


Advantages of Dividend Mutual Funds

Most investors who invest in dividend mutual funds generally seek a source of revenue. Dividends provide a constant and safe payment to an investor from their investment in mutual funds. Dividend mutual funds are best suited for retired investors due to their income-generating nature. Dividend mutual funds tend to be less risky than other kinds of funds, such as equity mutual funds.

A stream of high dividends indicates that the company is performing very well. Dividends are tax-free at the hands of the investor. Dividends represent the distribution of profits among the shareholders and are treated as the income of the shareholders. The tax on the dividends is called the Dividend Distribution Tax (DDT). Usually, the income tax is paid by the receiver of the income. However, DDT is paid by the company which is declaring the dividend. Therefore, dividend remains tax-free at the hands of the dividend holder.


Disadvantages of Dividend Mutual Funds

Since dividends are linked to profits of the company, an investor should only those dividend mutual funds which invest in profit-making companies. It is important to check the historical data of the dividend declaration of such companies before making an investment. A very high dividend declaration can indicate that the company does not have enough opportunity to expand.

These funds do not perform well in bullish markets. There is also a tax implication associated with dividend mutual funds. it actually destroys your money because of the tax on dividends. The dividend income which is in excess to Rs. 10 lakh in a year is chargeable at the hands of individuals, HUF, partnership firms or private trust. The present rate is 10%. If you sell your investment, you also attract a long-term capital gains tax on the dividend at the hand of the investor. The tax deductions reduce the amount of dividend or the returns you can earn from a dividend mutual fund.


How Dividend Mutual Funds work

In a dividend mutual fund, the fund house invests in stocks of companies that pay a high dividend. These companies generate high profits which allow them to declare dividends. Therefore, investments are made in stocks of companies that have a proven track record of declaring profits.

If you choose a dividend yield fund, the returns that you receive are the dividends declared by the underlying company.  If the investor chooses this option, dividends are usually sent directly by the fund manager to the investor.  The fund house is required to dispatch to the unitholders the dividend warrants within 30 days of the declaration of the dividend. In case of failure to dispatch the dividends within the stipulated time period, the fund house is liable to pay interest as specified by SEBI from time to time for the period of delay. The delayed interest is 15% at present.

You can also choose the dividend-reinvestment mutual fund. This mutual fund gives an investor the choice of reinvesting the dividends received. The dividend can be used by the fund manager to buy more shares. Reinvesting the dividend increases the number of shares owned and results in higher returns as compared to the dividend-yield option.


How to Invest in Dividend Mutual Funds 

Investors can invest directly or contact mutual fund agents for the necessary application forms that are needed. Investors must ensure that they invest through the Association of Mutual Funds in India (AMFI) registered distributors and that the distributor has a valid AMFI Registration Number (ARN).

Investors can also invest in dividend mutual funds directly without a distributor. For investments through the direct plan, the investor needs a financial adviser but does not have to pay any commissions to the distributors. This maximizes the returns as there is no commission paid.

Investors also have the option to invest directly with the mutual fund either by visiting the mutual fund branch or online through mutual fund website. Forms can be deposited with mutual funds through the agents and distributors who provide such services.

Before making an investment, the investor should take into account the track record of the dividend mutual fund/scheme. As per SEBI regulations, all the mutual funds are required to label their schemes on the following parameters:

a)  Nature of scheme – whether the aim is to create wealth or provide regular income in an indicative time horizon (short/ medium/ long term)

b)  A brief about the investment objective (in a single line sentence) followed by kind of product in which investor is investing (equity/debt)

c)   Level of risk depicted by a pictorial meter as under:

  • Low - principal at low risk

  • Moderately Low - principal at moderately low risk

  • Moderate - principal at moderate risk

  • Moderately High - principal at moderately high risk

  • High - principal at high risk

An investor should take into account the product labeling before investing in a dividend mutual fund.




What is the Net Asset Value of a mutual fund scheme?

The performance of a particular scheme of a mutual fund is indicated by the Net Asset Value (NAV).

NAV represents the market value of the securities held by the scheme. Since the market value of securities changes every day, NAV of the same scheme varies on a day to day basis. The NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on any particular date. For instance, if the market value of securities of a mutual fund scheme is INR 200 lakh and the mutual fund has issued 10 lakh units of INR 10 each to the investors, then the NAV per unit of the fund is INR 20 (i.e.200 lakh/10 lakh). NAV is required to be disclosed by the mutual funds on a daily basis.


Is it possible to make investments in dividend mutual funds through cash?

Yes, cash investments up to INR 50,000 per investor, per mutual fund, per financial year can be made in mutual funds. However, any repayment of the dividend is made only through the bank channel.


Can non-resident Indians (NRIs) invest in dividend mutual funds?

Yes, non-resident Indians can also invest in dividend mutual funds. The offer documents contain the necessary details for the same.


What should be the proportion of investment between debt and equity-oriented schemes? 

An investor should take into account his risk appetite, age factor, financial position, etc. There is no one size fits all investment strategy which applies to all the investors. Each investor should make a decision based on the investment objective and financial needs. The investor should also pay special attention to the offer document which contains all the details about the mutual fund.


I have made an investment in dividend mutual funds. Is there any way I can know of any changes that may occur in the mutual fund? 

There may be changes from time to time in a mutual fund. The mutual funds are required to inform any material changes to their unitholders. Many mutual funds send quarterly newsletters to their investors. At present, the Scheme Information Document (SID) is required to be revised and updated at least once a year. In the meanwhile, new investors are informed about the material changes by way of addendum to the offer document till the time offer document is revised and reprinted.


How can I be sure that the fund manager has invested my money in dividend mutual funds? 

As per the regulations of SEBI, the mutual funds are required to disclose full portfolios of all of their schemes on a monthly basis on their website. Portfolio disclosure on a half-yearly basis is also published in the newspapers.
Not sure which mutual funds to buy? Download moneycontrol transact app to get personalised investment recommendations.
First Published on Dec 3, 2019 03:45 pm
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