High Dividend Mutual Funds

 Dividend mutual funds are a type of mutual fund that pays a regular dividend to the unitholders of the mutual fund scheme, thereby creating a regular source of income for them. The investment strategy of the fund manager is to invest in a basket of companies that have a steady flow of income and promise to pay periodic payment to the investors.

Some investors prefer a regular source of passive income from their investments. Mutual fund schemes that offer a high dividend are a popular choice for such investors.

The frequency of payment of dividends is decided by the fund manager and is usually fixed.
Dividends can be paid daily, monthly, quarterly, six-monthly, or yearly, and the frequency of payment is mentioned beforehand. However, there is no guarantee on the rate and amount of the dividend to the investors and the payment of dividend is subject to the performance of the fund.

There are 2 types of dividend mutual funds based upon the asset class that they invest in.

1. Dividend Yielding Mutual Fund (Equity)
• Mutual fund schemes which invest more than 65% of their corpus in equity shares of companies
• Like any other equity scheme, they have the potential for higher returns, but also carry a higher risk
• Investors should invest in these schemes with an investment horizon of medium to long term

2. Dividend Yielding Mutual Fund (Debt)
• Mutual fund schemes which invest more than 65% of their corpus in debt instruments of government and corporations like treasury bonds, commercial papers, etc.
• These funds carry low risk and provide average returns to investors
• Interest received from the various instruments is paid as a dividend to the investors
• Investors should invest in these schemes with an investment horizon of short to medium term

Tax treatment for dividend mutual funds

Till now, dividend income received by the investor used to be recorded under the income head of “Income from other sources” and such income was tax-free in the hands of the investor.
However, as per the Union Budget 2020, the DDT is now abolished for companies and mutual funds. From April’20 onwards, any dividend received above Rs 5000 will be taxed in the hands of the investor. It will be taxed as per the individual tax slabs for both equity and debt schemes. Only debt investors who fall in the lower slabs of 10% and 20% will pay lesser taxes on dividends. For all the others, the taxation would be higher going forward.

Why should investors invest in high dividend mutual funds?

Dividend mutual funds offer unique advantages to the investors, especially when the macroeconomic condition of the country is weak; these investments provide the reliability of income to investors. The benefits of dividend mutual funds which should be kept in mind while investing in such funds
• Fund managers of dividend mutual funds invest in companies which can pay steady dividends and even if there is a slowdown in the economy, as companies do not want to send any negative signals, they avoid curtailing payment of dividends, thus making them less volatile than other funds.
• Overall returns from these funds are less affected as compared to other funds as the dividends provide a hedge against market volatility.
• In a low-interest rate regime, investors looking for a higher consistent income can opt for dividend mutual funds.

Disadvantages of a dividend mutual fund scheme

• Returns generated by dividend mutual fund schemes are lower as compared to growth schemes in case of rising markets
• These funds are not suited for aggressive investors looking for higher returns from their investment
• Moreover, with the abolition of Dividend Distribution Tax (DDT), investors in the higher tax-bracket will have to pay higher taxes on the dividend income.

Role of dividend mutual funds in a portfolio

Invest in dividend mutual funds with an investment horizon of 7 to 10 years for optimal returns. Investment in such funds should be a part of your strategic asset allocation and to lower the volatility of the overall portfolio. Aggressive investors can allocate less than 10% of their portfolio in such funds. Conservative investors, on the other hand, can allocate a higher percentage to these funds.

Essential things to keep in mind while investing in dividend mutual funds

• Conservative investors looking to invest in dividend funds should invest in large-cap funds, preferably of blue-chip companies that pay a higher dividend. Investing in companies with a higher proportion in mid & small-cap companies will increase the risk of the investment, thereby defeating the purpose of investment
• Invest in a fund which has been in existence for some time and witnessed a few market cycles
• Avoid investing in a fund with a small corpus to minimize risk as few wrong investment calls can significantly hamper returns
• The expense ratio plays a vital role in determining the overall returns from a scheme. Choose funds with a lower expense ratio

 

CONCLUSION

Investing in high dividend mutual funds is a good option if you are looking for a regular income through dividends. Consult our experts at IndiaNivesh to help you guide through the allocation of funds in these schemes as per your investment horizon and risk profile.

 

Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing. 

Ref: https://www.indianivesh.in/kb-blog/high-dividend-mutual-funds