On Mutual Fund Dividends
In today’s post Value Research’s Dhirendra Kumar has written on the misconception that mutual fund investors have about dividends. But most investors are aware that there is a difference between dividends from stocks and those from the mutual funds. Whereas in stocks, dividend means an additional income, in mutual funds the investor is withdrawing a portion of his own money. If I am paid Rs. 2000 from my mutual fund investment as dividend, the value of my investment will decrease on the date it is paid exactly by the same amount. So, Mr Kumar suggests that even if an investor needs regular income, it is better to keep his investments in the Growth Option of the fund and withdraw the amount he needs or to execute a Systematic Withdrawal Plan (SWP) to meet his monthly needs.
While admitting that it is wrong to think of mutual fund dividends as an additional income, an astute equity fund investor may not buy this argument. We must remember that dividends from equity funds are not taxed in India on the date of this post. The fund house does not pay Dividend Distribution Tax (DDT) while paying the dividend and the dividend is also tax-free at the hand of the investor. So, if an investor gets a dividend, he is earning tax-free income from day one. If he invests in the Growth Option of the fund, he will have to wait for one full year before any gains he made would be free from Long Term Capital Gains tax. Moreover, for the dividend payment no repeated action is required from the investor other than initially opting for the dividend option.
Secondly, if we want some sort of an income from our equity investments and want to withdraw some money, the fund manager may be in a much better position to judge when to take it out considering the market conditions, immediate prospect of earnings and valuations. So, one may ask that if the investor expects some income from his equity funds, isn’t the fund manager in a better place to decide when to pay dividends rather than the investor himself withdrawing some portion of his investment? If the fund manager is an expert on when, where and how much to invest, isn’t he also a better judge of when to take some money off the table and hopefully put it in the investor’s pocket?
The only drawback of the Dividend Option is that there is no certainty that dividends will be paid, nor is there any guarantee of the frequency and amount of that payment. But if an investor can take such uncertainties in his stride, it is much better for him to opt for the Dividend Option of an equity mutual fund rather than the Growth Option. There are funds like BNP Paribas Dividend Yield Fund that has been paying monthly dividends without fail for many years now. Some other funds, like Tata Equity PE Fund, have trigger options and declare dividends when the NAV increases by a certain percentage or the fund value crosses a certain threshold.
However, if you are an investor in non-equity debt or liquid funds which attract a DDT of more than 28%, unless you fall in the highest 30% tax bracket, it is better to opt for the Growth Option and start an SWP, preferably after three years, if you need a regular withdrawal.