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Mutual Funds
What is Dividend Yield? Definition, Types & How They Work
2 mins Read | 6 Years 10 Months Ago
Investing in stocks and equity mutual funds can be a smart way to grow wealth over the long term while also diversifying your portfolio. When investing in India, returns from equity investments generally come from two key sources, capital appreciation (an increase in the value of investments) and income distributions such as IDCW payouts (earlier called dividends declared by companies) in mutual funds. However, not all company profits are distributed to shareholders. This brings us to Dividend Yield, an important measure to help investors understand how much return they are earning from dividends compared to the stock price. In this blog, we will explain what is dividend yield, how it works, and its importance. We will also talk about the Dividend Yield Mutual Funds and their benefits.
Understanding About Dividend Yield
Dividend yield can be defined as the ratio of a company’s annual dividend payment per share to its current market price per share. In simple terms, dividend yield tells investors the percentage return earned through dividends based on the stock’s current market price.
Let us take an example to understand it better. Suppose that a company’s share price is ₹200 and it pays an annual dividend of ₹10 per share, then the dividend yield would be calculated as:
Dividend Yield=(10/200)×100=5%
It simply means that you earn 5% annually as dividend income, in addition to any capital gains if the stock price rises.
Why is Dividend Yield Important?
The importance of dividend yield cannot be underrated. Here is why it is important for investors:
- Income Potential – Investors who are looking for a regular cash flow, high dividend yield stocks can offer a steady income.
- Company Stability – Companies that consistently pay dividends tend to be stable and financially strong.
- Valuation Insights – A very high dividend yield may indicate that the stock price has dropped, which could be a warning sign about the company’s future prospects.
Dividend Yield Levels
Below are the important types of dividend yields:
High Dividend Yield
These are companies that offer relatively higher dividends compared to the market average. Such companies are often found in mature sectors such as FMCG, banking, energy, and large public sector enterprises. These stocks are attractive for investors looking for regular income rather than aggressive growth.
Low Dividend Yield
Growth-oriented companies pay little or no dividends, as they prefer reinvesting profits back into the business. While the dividend yield may be low, these stocks often have higher capital appreciation potential.
What Are Dividend Yield Mutual Funds?
Dividend Yield Mutual Funds are equity schemes that primarily invest in dividend-yielding stocks. As per SEBI categorisation norms, these funds must invest at least 65% of their total assets in equity and equity-related instruments of dividend-yielding companies.
Since these funds often invest in established, dividend-paying companies, they may be relatively less volatile than some aggressive equity categories. They offer a balance of regular income through dividends along with moderate growth potential, making them an appealing option for conservative equity investors.
Learn the Working of Dividend Yield Funds
Let us learn the simple working of these funds:
- Starting with the fund manager, they choose companies offering high dividend yields, strong fundamentals, and reliable profit records.
- Here, the focus is not just on dividends but also on the dividend yield. It simply means that the companies with reasonable share prices that make the yield attractive are chosen.
- Dividends received from underlying companies become part of the fund’s assets and are reflected in the NAV. Any payout to investors depends on whether they have selected the IDCW option.
One important point to note is that When an IDCW payout is made, the fund’s Net Asset Value (NAV) reduces to the extent of the distribution because the payout comes from the scheme’s assets. This is because the value distributed as dividends comes out of the fund’s assets.
Features of Dividend Yield Mutual Funds
The key features of dividend yield funds are discussed below:
- Stable Companies – Dividend yield funds are known to invest in large, financially strong companies that are less affected by market changes.
- Regular Income – These funds may provide periodic income opportunities depending on the fund strategy and the option selected (Growth or IDCW).
- Equity Exposure with Lower Risk – When compared to aggressive equity funds, these funds may involve relatively lower volatility than aggressive equity funds because of their investment style.
- Moderate Growth Potential – While returns may be more moderate than high-growth equity categories during bull markets, they can offer a balance between income potential and capital appreciation.
Benefits of Investing in Dividend Yield Funds
Below are the benefits that are important to know:
- Regular Income Source
For retirees or conservative investors, these funds provide a steady income stream in addition to long-term growth.
- Lower Volatility
There is a chance for less volatility, which is because these funds invest in strong-backed companies, which ultimately reduces the risk of market fluctuations.
- Diversification
These funds are also known to offer more diversification for investors. This is due to the equity exposure while also balancing risks, making them a beneficial addition to your portfolio.
- Long-Term Returns
Over time, consistent dividend payouts and moderate capital gains can deliver healthy risk-adjusted returns.
Who Should Invest in Dividend Yield Mutual Funds?
These funds are suitable for:
- Investors looking for regular income along with capital appreciation.
- Conservative equity investors who want exposure to the stock market but with reduced volatility.
- Those with a medium to long-term investment horizon.
- Retirees or individuals who need a steady secondary source of income.
They may not be ideal for aggressive investors seeking high short-term growth.
Taxation of Dividend Yield Mutual Funds
As per the Union Budget 2024 rules:
- Long-Term Capital Gains (LTCG) – Taxed at 5%, exemption up to ₹1.25 lakh annually.
- Short-Term Capital Gains (STCG) – Taxed at 20%.
- Dividend Income – Attracts 10% TDS if annual dividend exceeds ₹5,000.
Additionally, for debt-oriented dividend yield funds, there is no indexation benefit for investments made on or after April 1, 2023. All profits are taxed at the investor’s income tax slab rate.
Conclusion
Dividend yield is an important concept for investors who value both stability and income. Dividend yield mutual funds, by investing in companies that pay consistent dividends, provide a balanced option for those looking for regular income with moderate risk.
While they may not generate the highest returns, they offer peace of mind, lower volatility, and a steady cash flow. With the right understanding of their features, risks, and taxation, dividend yield funds can be a reliable part of a well-diversified portfolio.