While dividends from mutual funds can be a benefit for people looking for regular income, there is no guarantee that they will be paid regularly as dividends are paid out of the profits made by the fund through selling securities. For those who want to build wealth long-term, the growth option is more suitable. Dividends are exempt from tax for investors but subject to Dividend Distribution Tax at the source.
With the promise of regular dividend payments, fund advisors lure investors into mutual funds. Although regular dividends sound appealing and can be a great benefit to some investors, it may not be the right choice for others. Your financial goals will greatly influence your decision to choose dividend options in mutual funds.
Let’s first understand what dividend is in mutual funds?
Dividends from mutual funds are paid out of the surplus or profit that is generated by the sale of securities in the scheme’s portfolio. Mutual funds may also have fixed-income securities or dividend paying stocks as part of their portfolio. These underlying securities must pay interest or dividends to the scheme.
Let’s look at how dividends could impact your investment.
Dividends are calculated as a percentage from the face value of mutual fund schemes. The scheme’s NAV falls to the amount of dividends declared on the ex-dividend day. Let’s say you have 100 units of a scheme having a current NAV of INR20 and whose face is INR10. The face value refers to the price at which the scheme was launched. Let’s say that the scheme pays a 20% dividend. You will be paid INR2 per unit as a dividend. The dividend will be INR200 and the NAV for your scheme will drop to INR18 at the ex-dividend. Your investment would have been worth approximately INR 2000 if the fund house had not declared dividend. Your investment now stands at INR 1800, and you receive INR 200 in dividends. Dividends can be compared to redeeming units. You would be in the same place if you had sold 10 units.
A mutual fund dividend doesn’t impact your overall financial position, so why not go for it?
Dividend pay-out is the best option for investors looking to receive regular income from their investments. You should choose the growth option to build wealth long-term. This will allow your NAV to grow more quickly than other dividend options such as reinvestment or pay-out. The NAV of the growth option would remain at INR 20 after the ex-dividend date in the example above. If you consider the effect of dividends on the NAV of the scheme, which can be up to 10 years, the gap between the NAVs will be large.
Dividends from mutual fund funds are exempted from tax, but they are subject to Dividend distribution Tax (DDT) at the source. The scheme’s DDT reduces the amount of distributable surplus that is available to investors. Equity-oriented schemes with >=65% allocation of equity to equities are currently subject to 10% DDT, 12% surcharge, and 4% cess. This makes the effective DDT 11.648%. Non-equity-oriented funds and Infrastructure Debt Funds will be subject to 25%DDT, 12% surcharge, and 4%cess. A growth option is more likely to create wealth over the long-term, as DDT’s effects compound over time.
