Do you want your mutual fund investments to generate regular returns? You may consider investing in dividend-yield mutual funds. Read this post to know what they are and how they work.

What is the best type of mutual fund scheme? Well, the answer will vary based on who you ask. While some investors prefer high-risk schemes that could generate potentially higher profits, many others aim for reasonable, low-risk return schemes.

Then there are investors who expect their mutual fund investment to generate a passive income. If you belong to this category of investors, dividend yield mutual funds deserve your attention.

Let’s take a detailed look at these dividend-paying schemes-

What are Dividend Yield Mutual Funds?

Equity as an asset class is known to reward investors through capital gains. But it can also generate returns in the form of dividends. Dividend yield equity funds leverage this dividend-generating capability of equities, providing investors with an investment option with the potential to deliver regular returns.

As per SEBI, a dividend yield fund invests at least 65% of the portfolio in stocks. As profit-making companies with a healthy cash flow are generally the ones announcing regular dividends, a significant portion of the portfolio of dividend yield equity funds is typically reserved for such companies.

How does Dividend Yield Funds Work?

The dividend yield is defined as a certain percentage of the stock price. Stocks with a reasonable market price that pay good dividends regularly are known as high dividend yield stocks. Dividend yield mutual funds predominantly invest in stocks of such companies. Stocks with a higher market price, even if they pay regular dividends, are avoided by these schemes as they have a lower dividend yield.

For instance, let's say the dividend yield of NIFTY50 is currently around 2.20. So, a dividend yield fund with NIFTY 50 as its benchmark will allocate a major portion of the portfolio to companies with a dividend yield above 2.20. But while investments are made in stocks with an excellent track record of dividend payments, the dividends depend on the market performance of particular equity and are not guaranteed.

Who Should Invest in Dividend Yield Mutual Fund?

Now that you know what is dividend yield fund, let’s take a quick look at who should add these schemes to their portfolio-

• Low-Risk Investors Looking for Equity Exposure

  Equity investments can be risky and volatile. However, the risk level varies significantly between stocks. For instance, companies with high-market capitalisations are better positioned to ride through short-term market volatilities. Risk-averse investors who want to add some equity exposure to their portfolio can consider investing in such financially sound companies via dividend yield equity funds.

• Investors Who Want a Combination of Capital Appreciation and Dividend Income

  If you want your equity investment to provide you with a regular income, a dividend fund can be worth considering. In the longer run, the investment can potentially help with wealth creation through capital appreciation, while the dividend payments can support short-term objectives. But note that the dividend amount or payment frequency is not guaranteed.

• Build a Diversified Portfolio

  If you want to build a diversified portfolio, dividend-yield funds can help. As the majority of the investment by these schemes is in large-cap companies, they are generally not as volatile as small-cap and mid-cap equity funds. Hence, they can be added to an aggressive portfolio to optimise or balance out the risk.
  
  Also Read: Types of Mutual Funds

Factors to Consider Before Investing in Dividend Yield Mutual Fund

Keep these points in mind before investing in a dividend yield fund-

• Scheme Allocation

  Many risk-averse investors who want some equity exposure invest in dividend yield funds. If you’re looking for the same, don’t forget to check the scheme’s portfolio. Ensure the scheme mostly invests in large-cap companies to keep volatility low.

• Dividend Payment History

  Even though the dividends are not guaranteed, some schemes are historically more consistent with dividend payments than others. So, check the dividend payment history of the companies in the scheme before investing. But remember, the past performance of the scheme does not influence its future prospects.

• IDCW or Growth Plan

  Like most other types of mutual fund schemes, dividend yield funds also offer growth and IDCW (Income Distribution Cum Capital Withdrawal) options. With the growth option, the profits are reinvested in the scheme, while the dividend option pays out to the investors at intervals. Choose between growth and IDCW according to your investment goals.

Generate Regular Income with Dividend Yield Mutual Funds

Dividend yield funds can potentially be one of the ways to generate additional income from your investment through dividends. But as dividend payments are not guaranteed, invest only after thoroughly understanding how these schemes work and the risks involved.

You can consult with an investment advisor before investing to ensure your strategy aligns with your goals and risk appetite.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.