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What is Dividend plan in mutual funds, how to buy, and factors to consider while going in for dividend plans?

  • Rudri Rawell
  • Jan 12 2022
  • 6 minutes
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Mutual fund schemes come with two broad options, namely growth and dividend. The growth option provides returns in the form of an increase in value of mutual fund units. The dividend option, on the other hand, offers returns through periodic dividends. 

Investors often get confused between the two and wonder whether a growth fund is better than dividend plans. It is important to note that one option is not necessarily better than the other. Investors should choose an option that is more suited to specific investment needs, financial objectives and tax benefits. 

In this article, we will explain the dividend plan in mutual funds and how they work.

What is a dividend plan in mutual funds?

As per SEBI guidelines, the dividend option in mutual funds has been renamed to ‘Payout of income distribution cum capital withdrawal’ option effective from April 1, 2021 and mutual fund houses/distributors can no longer call them as dividend plans.

In a dividend plan, profits made by a mutual fund scheme are paid out to investors at regular intervals. The most common pay-out interval for dividend plans is yearly. Some mutual fund schemes may also offer pay-out intervals such as daily, monthly, quarterly, etc. Some schemes may also offer multiple pay-outs. 

One of the types of dividend option within mutual fund schemes is dividend reinvestment option. Under this, the dividends paid to investors are reinvested in the mutual fund scheme. 

Here are some important features of dividend plan:

  • As per SEBI regulations, dividends must be paid to investors from the accumulated profits of the mutual fund scheme.
  • Mutual fund schemes give no assurance on dividend pay-out rate or timing of pay-outs.
  • The dividend paid to investors is adjusted from the NAV of the scheme. Hence, there is often a drop in NAV (ex-dividend NAV) of the mutual fund scheme post dividend payout. If it’s a dividend reinvestment option, the unit balance generally goes up.
  • Dividends paid out by both equity and debt mutual funds are taxable in the hands of the investors. The tax is calculated as per the applicable income tax slab of the investors.

Who can buy dividend mutual funds?

A dividend mutual fund is an ideal investment option for investors who:

  1. Are looking for a regular source of income:

Dividend plans in mutual funds can be a good source of income for investors who prefer to buy additional mutual fund units. The income flow can also be used to meet other personal financial goals.

  1. Have a low-risk appetite:

Dividend plans are often compared to growth plans in terms of being a low-risk investment offering valuable returns. Hence, investors who are risk-averse can opt for dividend mutual fund units.

  1. Amateur investors:

Even if an investor is less experienced or is a first-time investor, dividend plans in mutual fund investment can be an apt choice. The primary reason is that it poses minimum investment risk as compared to direct stock investments.

How to buy a dividend plan?

There are two ways to invest in dividend mutual funds – Online and Offline

Offline:

  • An investor has to visit a broker or approach the Asset Management Company for investment
  • Investors must keep certain documents handy–PAN card, Aadhaar Card, Cancelled Cheque, Passport size photos, KYC documents. These are primary requisites to begin the investment.

Online:

  • Investors can visit the Asset Management Companies (AMCs) website or download the Finity app since it offers different mutual fund products under a single umbrella
  • Investors can do basic research by comparing various dividend plans
  • After selecting the one that is best suited, investors can begin investing by completing the application formalities online.

Are dividend mutual fund plans worth investing in?

Mutual fund dividend plans suffer from a dual problem since dividends are paid from the capital growth of investment and profits made by the investor. Thus, in these plans, an investor ends up getting back his/her own investment in the form of a dividend. Effective from FY21, the dividend distributed by mutual funds is taxable at income tax slab rates which may result in payment of tax on an investor’s capital.

Here’s an example to better understand the tax treatment of dividends in mutual funds. A mutual fund was launched at a net asset value (NAV) of Rs. 10 and it appreciated to Rs. 15. An investor invests in the fund at Rs. 15 and its value further increases to Rs. 17. 

At this time the fund books its profits and declares a dividend of Rs. 7, due to which the NAV of the fund comes back to Rs. 10. The investor gets back the profit on initial investment (Rs. 2) and also Rs. 5 which is his own capital. The total dividend amount (Rs. 7) is taxable at the income tax slab rate of the investor (which can also be 30%) even though the real profit made by the investor is only Rs. 2. 

Thus, dividend plans may not be as beneficial to investors as growth funds. 

Factors to consider while buying dividend plans

Some of the important factors to note while buying dividend mutual fund schemes are:

  • A high dividend payout may be an indication that the company may be out of growth opportunities
  • Investors should not expect dividend-yielding mutual funds to continue paying a fixed amount in fixed timelines
  • Total returns offered by dividend options could be lower as compared to growth options in the long term. This is primarily due to periodic payouts.

Conclusion

Investors who have a low-risk appetite and want to earn higher returns in the short term can choose to invest in dividend mutual funds. Before planning an investment in dividend funds, investors must make sure to study the fund’s consistency of dividend payout and historical performance.

FAQs

  1. Are mutual fund dividends the same as stock dividends?

Mutual fund dividends are different from stock dividends. Stock dividends represent profits earned by a company. However, mutual fund dividends are not a reflection of the profitability of a mutual fund scheme. High mutual fund dividends are not an indication of fund performance. 

  1. When are mutual fund dividends declared?

A mutual fund reserves the right to declare dividends. An investor cannot have a say in this. However, an investor can decide the timing of buying or selling his/her mutual fund units and generate capital gains, if any.

  1. Is dividend option better than growth in mutual funds?

The criteria to choose between growth and dividend mutual funds varies across investors and is dependent on his/her investment objective. While growth option allows investors to focus on long-term capital growth, dividend option is ideal for investors who are looking for a regular income source.

  1. How do I choose a good mutual fund?

To choose a good mutual fund, an investor must look at the historical performance of the fund along with performance against benchmark. Investors must parallelly focus on aspects such as personal investment objective, investment time horizon, and risk/return appetite while selecting the right fund.

  1. Can I invest Rs. 1,000 in a mutual fund?

Yes, mutual fund investments can be started with a small amount as little as Rs. 1,000. Investors can also opt for the SIP mode of investment if they prefer to invest small amounts periodically.

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