What is Dividend?
Dividends are important corporate action that attracts investors to invest in a particular stock in the secondary market segment of stock market. There are investors who invests exclusively in high dividend paying stocks. They are conservative investors who look for regular income and who wants to lock in the profit by way of dividend well before exiting the stock with capital gains.
Companies share part of their profit as dividends with existing shareholders. Usually they declare dividends annually and in case of special events such as golden jubilee year of the company or on excess operational profits earned, they declare interim dividends.
Dividends in Mutual Funds Sahi Hai!
But most of the investors understand the dividends declared by mutual funds in similar manner. But to their disappointment, it is to be noted that the dividends declared by mutual funds are not paid out of the profits they earn, but they are only repaying part of the investment made by the investors. So, this brings down the investment made by the investors and the investor loses the compounding benefit of his investment.
All mutual fund scheme comes out with three plan options viz., growth, dividend and dividend re-investment plans.
- While growth plans does not declare any dividends, dividend plans declare regular dividends.
- When a fund pays dividend, the NAV of the fund will reduce to the extent of the dividend paid. Whereas, the NAV of the growth fund remains the same as there is no payment of any dividend.
- There is another option as dividend re-investment plan, where dividends declared are re-invested in the scheme. In this plan dividends declared are not actually paid to investors, but they are allotted units for the dividend amount. However, the NAV under this plan will be reduced to the extent of dividend declared.
We’ll take an example of Axis Blue Chip Fund and let us understand what happens to the investment made in growth plan and dividend plan.
Let us assume two different investors named Amar and Akbar invests in this fund at the time of its launch at issue NAV of Rs.10/-. Amar opts for growth plan and Akbar opts for dividend plan.
The fund declared its first dividend of Rs.1.2 per unit during February 2013 and regularly paid dividend every year till current year 2019. In this scenario let us analyze the investment made by Amar and Akbar under growth and dividend plan.
We can see from this real example of Axis Blue Chip Fund, Amar who was assumed to have invested in growth plan had earned a return of 178.70% whereas Akbar who was assumed to have invested in dividend plan had earned a return of 135.08% after 9 years of investment. So, Akbar’s returns from dividend plan is very less compared to returns earned by Amar under growth plan.
When an investor opts for dividend plan, he is exposed to double taxation on the dividend received. This is because, companies pay dividends to mutual funds after deducting dividend distribution tax (DDT). Mutual funds will again deduct net DDT @ 11.648% and pays the balance to investors. Whereas, long term capital gains tax is just @ 10% if it exceeds Rs.1 lakh. So, the outgo by way of tax is more for the investors in dividend plan than for investors in growth plan.
In debt funds too, dividends are paid to investors after deducting DDT of 25%. While, if one had invested in growth fund and holds for long term of more than 3 years, he will be paying only capital gains tax @ 20% with indexation benefit.
Systematic Withdrawal Plan (SWP) – An alternative
So, thinking how to get a regular income along with growth benefits! There is a solution to this problem called SWP. You can invest in growth plan and structure a Systematic Withdrawal Plan (SWP) such that each month you withdraw a part of the capital and a part of the returns. In this case, you pay capital gains tax only on the return portion and not on the principal portion making it more tax-efficient, even while ensuring regular income.
Considering the taxation of dividend and the lower returns, it will be a wise choice to invest in growth plans and opt for systematic withdrawal plan. This makes more sense for investors who wish to create wealth as well as get regular income. Investors who are risk averse and investors who look for regular income to meet their short term financial needs can invest in growth fund with structured SWP. Even for debt fund investors, the withdrawals can be structured as a SWP instead of a dividend.
The impact of dividends declared by mutual funds are different from the dividends declared by companies. Investors who wish to invest in high dividend paying companies and reap the benefit of dividend income can do so by opening an online trading account with stock broker. And to track the dividends declared by companies from time to time one can view it from the NSE website.
Now having cleared about the myths of dividend plan in mutual funds can we say #mutualfundssahihai
Investors who wish to directly invest in high dividend paying stocks CLICK HERE to open an online share trading account and investors who wish to invest in mutual funds CLICK HERE to open an account.
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