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Many investors, especially retirees, choose the dividend option in their Mutual Fund schemes assuming that these pay-outs are guaranteed or assured in nature.
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Several investors choose to invest into the dividend option of their selected schemes, instead of the growth option. If you’re one of them, you’ll want to make sure that you don’t harbour these fallacious beliefs about Mutual Fund dividends. Remember that switching from the dividend option to the growth option of a fund will attract loads and taxes, so you’re better off deciding your preferred mode of investment at the beginning.
They aren’t Tax-Free
While it’s true that Mutual Fund dividends are tax-free in your hands, they aren’t tax-free at the source. Dividends arising from Equity Mutual Funds attract a DDT of 10 per cent (plus surcharge and health and education cess), and what you get in your hands is after the deduction (they were tax free until the Budget 2020). Dividends from all other funds (including Monthly Income Plans, international funds and gold ETF’s) are taxed at source at a high rate of 28.33 per cent. In other words, if your debt fund declares a dividend amounting to Rs. 100, what will be credited to your account is just Rs. 71.67. It’s actually more rewarding to just choose the growth option and redeem the required “dividend” amount yourself, creating an artificial dividend in the process.
They are not “additional profits”
Many investors choose the dividend option believing that they will earn higher returns than their growth-option selecting counterparts, as these dividends will be declared over and above their regular capital gains. In reality, dividends are paid out from the capital gains themselves! Here’s how they work, in a nutshell. Say, your fund value (in the dividend option) has grown from Rupees 1 Lakh to Rupees 1.5 Lakhs, and the fund house declares a dividend that translates to Rs. 25,000 for you. Post the dividend pay-out, the NAV (net asset value) of the scheme will recalibrate itself to reflect the quantum of the pay-out. This is known as the “cum-dividend” NAV and will be lower than the “ex-dividend” NAV. In other words, your fund value will fall to Rs. 1.25 Lakhs, after the dividend is declared.
They are not guaranteed or assured
Many investors, especially retirees, choose the dividend option in their Mutual Fund schemes assuming that these pay-outs are guaranteed or assured in nature. In reality, dividends from equity oriented schemes can be extremely erratic, and these funds can sometimes go several months without paying a dividend. Even dividends from hybrid funds that have just 20-25 per cent of their portfolios invested into equities can vary dramatically in their pay-out frequency or quantum. If you’re looking for a more consistent cash flow from your portfolio - for instance, to meet your essential monthly expenditures, SWP’s (Systematic Withdrawal Plans) represent a much better option.