Fallacy of dividends in mutual funds

Use the liquidity feature of mutual funds instead of going for a dividend option when investing in mutual funds
Fallacy of dividends in mutual funds
Fallacy of dividends in mutual funds

Okay, there are investors who swear by the dividends they receive every month on their mutual fund investments. Little do they realise that the concept of dividends in mutual funds is not the same as receiving dividend when investing in stocks or the interest payout that happens in a bond of fixed deposit. For instance, a dividend in case of stocks is actually the reward paid by the company where the board decides to pay cash dividends to shareholders.

Not all companies, even when doing well pay out dividends. Although Infosys as a company has healthy financials with ample cash in its reserve, it has not declared dividends regularly. The reason for not paying out dividends could be due to several reasons, but the prime reason for holding dividends is mostly to do with plans to deploy the monies for expansion and acquisitions. At the same time, there are companies like Reliance Industries, which do pay out dividends regularly; it is the company’s way of rewarding investors to retain their interest in the stock.

Why MFs differ

The concept of dividends when investing is very unlike the above scenario, because dividends really do not matter when investing in equity mutual funds. First, unlike dividends from stocks that are paid from cash reserves, mutual fund dividends are actually paid from your own investments. In effect, your own money, which is nothing but the growth in value of your investments, is paid out to you, which means the NAV of the dividend option falls the moment the dividend is declared.

Further, mutual fund dividends are neither guaranteed nor follow a defined time schedule unlike say fixed deposits. So, if you are looking at creating an income stream from your mutual fund investments, instead of opting for a dividend option, you could redeem the units you hold with the liquidity feature that mutual funds offer. It is for this reason that it makes more sense to go for the growth option when investing in mutual funds than opt for the dividend option. Moreover, dividends from equity funds are exempt from tax, irrespective of when you receive it.

Though dividend on debt funds does attract tax, you do not pay this tax – called dividend distribution tax (DDT). The AMC deducts it from your NAV and remits it directly, which means you receive the dividend net of DDT. The DDT rate for individuals at present is 28.84 per cent (including surcharge and cess). Do note that as dividends are paid out from your NAV, your NAV falls post such dividend payout or reinvestment. Hence, the capital gains, if any, when you sell your units under this option will seem lower. But the fact remains that you paid tax on the dividend, which is nothing but part of your profit. Do make sure you understand what you get when you opt for the dividend option when investing in mutual funds before blindly chasing dividends. 

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