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Recently, one of my friends and I had a heated argument on insurance. He is an insurance salesman and I am, well, an insurance atheist. He made an interesting point: while a mutual fund may deliver a higher return, he cannot force someone to save regularly through the mutual fund route because the sky does...

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Fund dividends - picking your own pocket

A mutual fund dividend payout is just taking your own money and giving it back to you

A spate of advertisements by fund houses about dividend payouts from various schemes has been enriching the print media of late. How do you use the dividends in a mutual fund at all? You have a corpus NAV, which gets reduced not only by the dividend payout but also by the amount of dividend distribution tax that is paid to the government of India. Unlike a business entity dividend, the mutual fund dividend is eyewash and is of use only to some tax avoidance or evasion entities.
 
It is no sign of prosperity of the mutual fund. Dividend option is good for those who seek tax-free income in the short term. In equity mutual funds, if your holding period is beyond one year, then any gain on sale of mutual fund units is tax-free to the investor. In such a case, why opt for dividend and then suffer the payout to the government of India?

The corporate sector uses the dividend option in liquid funds, because of tax arbitrage. Even with the dividend distribution taxes, they still make some extra money in the short term. For an individual also, a daily dividend scheme in a liquid fund does make some sense.

When the new Direct Taxes Code comes in, probably we would have to search for new loopholes.

However, when it comes to equity schemes, a dividend payout helps only someone who wants to indulge in ‘dividend stripping’. For this to happen, one has to be holding the units either three months before the dividend date or for nine months after the dividend payout. Let us assume that the pre-dividend net asset value (NAV) of a scheme is Rs20 and that there is a dividend of Rs4. Once the dividend is paid out, the NAV will decline to say around Rs15.12 (Rs4 for the dividend and 88 paise as the dividend distribution tax to the government). After a year, let us assume that the NAV has not moved at all. In this case, you have a ‘loss’ of Rs4.88 when you sell the units which can be offset against short-term gains. Of course, you have taken away Rs4 as dividend, which is like agriculture income, i.e., tax-free! A lot of HNIs use this route and many fund houses discreetly market the dividend payout three to four months in advance. Of course, it is illegal to announce dividend intentions so early, but who the hell cares about the law? Many schemes, if analysed, show healthy inflows around three to four months before the dividend payout.

A mutual fund dividend is taking your own money and giving it back to you. In the process, the dividend distribution tax chips away at some of your asset value. This distribution tax is not applicable if you are a non-taxable entity like a charitable organisation.

As a retail investor, stay put in the growth option. You will be better off. Whenever the fund pays a dividend, the NAV drops by the dividend payout plus the dividend distribution tax.

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COMMENTS

knarang

8 years ago

do not think more ang more and awit
futures of mutual funds investments.wait and watch

lowkeyfan

9 years ago

Frame Dependence is a reality in behavioural finance wherein an investor will treat money in his left pocket differently from the money in his right pocket. Your arguments are all valid in a frictionless traditional finance model. In real life however, individuals will have biases including that of Self-control and Regret Avoidance. Those who are ageing will want to consume only at a rate that keeps their perceived wealth intact and use away dividend incomes to restrain expending beyond a rate that causes them to superannuate. Howsoever logical it may be to own the growth schemes and sell proportions of that to meet expenses, it is a difficult thing to do for individuals who are all made differently by the Almightly. Behavioural biases is what makes two different sets of value at the same price causing markets to trade, investments to become possible and this column to be a necessary and required reading.

Ian Hude

9 years ago

All this is true but in the growth option one reduces the number of units when one does a cash out ( as also in a dividend option cash out between dividends).
But in the dividend option the NAV rises with the market also and the number of units undiminished is a benefit in that event.

[email protected]

9 years ago

IT IS TRUE THATDIVIDEND PAYOUT IN MUTUAL FUNDS comes from investors own pocket,but it cheers the.and think as pention to fulfill their needs.if share market goes down the pay out is benficial. in my opinion one should take payout to fulfill his small requirments.ONLY those who have no need money.can take growth option.

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