There are various categories and types of mutual funds but one category with probably the least number of schemes in it is the ‘Dividend Yield’ category.
Dividend Yield mutual funds are probably the least
discussed, analysed and invested in among all the categories of mutual funds.
This can easily be ascertained by the Assets Under Management (AUM) that funds under this category hold.
What is
a Dividend Yield mutual fund?
- A dividend yield mutual fund is a mutual fund scheme that invests in companies that have historically declared dividends perpetually for a long time.
- Therefore, by default it means these mutual fund schemes invest in companies with strong balance sheets, highly efficient management and a robust functioning in place.
This is because a company can only declare high dividends
only if it makes good profits and it can only make good profits when it
satisfies all the qualifications mentioned above.
It is not enough that these companies pay high dividends
consistently to qualify for a dividend yield mutual fund, they also need to
have a high dividend yield.
The fact that the fund has to invest in a particular set of
stocks, makes the job of the fund manager easier considering his choices are
limited anyway.
A dividend yield fund is not one that pays dividends regularly, it is one that invests in companies that pays dividends regularly.
The name of the fund denotes the approach of the fund rather
than a willingness or potential to pay dividends.
What
are Dividends?
Dividends are declared by companies when they make profits.
Usually strong companies who are leaders in their respective
sectors declare dividends since well run companies are more likely to make
profits than the not so well-run ones.
There is no obligation on companies to declare dividends only
because they make a profit, at times they may decide to keep a hold of their
profits entirely for other purposes.
A company declaring dividend, a mutual fund declaring
dividend and a dividend yield mutual fund are all 3 different things and do not
mean the same.
What
does Dividend Yield mean?
- Dividend Yield is the dividend paid per unit divided by the market price.
- It is the ratio of past paid dividends to the market price per share.
- This includes both partial and full dividends.
Companies that pay dividends usually do so annually and then
there are some who may even do so more than once in a year.
A dividend yield ratio most importantly takes into account
the price of stock of the company.
If the stock price of a company is low for whatever reasons
but it has a good history of pay dividends regularly then it would be preferred
over a company with a high price and having a good track record of paying
dividends.
Dividend
paying mutual funds and Dividend Yield mutual funds
The dividend option in a mutual fund scheme and a dividend
yield mutual fund scheme are not the same thing.
The dividend option in a particular mutual fund merely means
that you are eligible for dividends as and when the mutual fund scheme declares
so.
It is not mandatory for the mutual fund scheme to declare
dividends though and there is no guarantee of the same.
A dividend yield mutual fund on the other hand invests in
companies with a high dividend yield ratio, meaning companies that have a good
track record in declaring dividends and their stock prices are at an attractive
valuation.
Additional reading: Click Here to read our complete review of Kotak Standard Multicap Fund.
Advantages
of Dividend Yield mutual funds
A dividend yield mutual fund would by default only be
investing in quality stocks.
This is because only quality companies would be in a
position to declare dividends on a regular basis.
This therefore means that the portfolio is only built with
quality stocks.
Since the portfolio is made up of quality companies, it
helps the fund to counter volatility which is a given with equity investing.
These funds provide a better risk reward for a medium to
long term horizon outlook.
Disadvantages
of Dividend Yield mutual funds
- The portfolio of such funds is restricted in terms of their choices.
- They can only invest in stocks of companies that have a high dividend yield ratio.
- Therefore, their hands are tied when it comes to portfolio diversification.
These funds are not restricted with regards to caps be it
large cap, mid cap or small cap.
There is a possibility then that these funds could allocate
a higher proportion to mid and small cap companies.
Mid and small companies tend to fall the most in a volatile
market.
The fund manager would be going with stocks of companies
with a high dividend yield, irrespective of the cap.
Mid and small cap mutual funds need to be well diversified
so as to face volatile times efficiently but that cannot be the case here since
the fund manager’s choices are limited.
He/she can only pick mid and small cap companies with a high
dividend yield ratio.
Which
mutual fund is best for monthly income?
Neither dividend yield mutual funds nor mutual funds with
dividend paying option are a good source of monthly income.
The taxation system applicable makes it for a very poor
choice.
If you are looking for a mutual fund that can help you with
a monthly income, then it is better to go with the Systematic Withdrawal Plan
(SWP).
In a SWP you can withdraw a fixed or variable amount either
weekly, monthly or quarterly depending upon your requirement.
Ideally the principal amount from where you make this
withdrawal should have completed a minimum of 3 years (the longer the better)
for conservative funds and longer for aggressive and moderately aggressive
mutual funds.
You should only invest in a dividend yield mutual fund if it adds something new to your existing portfolio, is not part of your core portfolio and you have a very good understanding as to the strategy applied by your dividend yield scheme because every dividend yield mutual fund functions in a manner that is distinct from the rest.
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