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How Mutual Fund Dividend Works

In this article, we will discuss the why and how of mutual fund dividends for investors looking for a regular income from their mutual fund investments.

Mutual fund choices based on investor’s objectives

Mutual fund schemes offer various investment options to investors depending on their investment objectives. For example, investors who want long term returns without any regular income can invest in mutual funds with growth options. On the other hand, investors who need regular income can invest in mutual funds with the dividend option. In this article, we will discuss the why and how of mutual fund dividends.

What are mutual fund dividends?

Depending on its type and objectives, a mutual fund scheme invests in various securities like equities, fixed income instruments, etc. When the scheme makes profits on its investments, the fund manager may decide to book profits from time to time. These profits are shared with the scheme unit holders from time to time in the form of dividends.

How do mutual fund dividends work?

The dividends declared by a mutual fund scheme depend on its accumulated profits and booked profits. While most mutual fund schemes declare dividends annually, some schemes declare daily, monthly, or quarterly dividends. However, there is no assurance that a dividend will be declared. Moreover, even if a dividend is declared, the frequency of the dividend and the dividend per unit will vary, again depending on the scheme profits.

When a mutual fund scheme declares a dividend, it announces the record date. It acts as the cut-off date and helps decide the mutual fund unitholders eligible for receiving the dividend. The scheme’s net asset value (NAV) gets adjusted with the dividend per unit amount on the ex-dividend date.

For example, the NAV of the scheme is Rs. 32/unit. The scheme declares a dividend of Rs. 2/unit. On the ex-dividend date, the NAV of Rs. 32 will get adjusted by the dividend amount of Rs. 2 to the NAV of Rs. 30.

The dividend amount is credited to the unit holder’s bank account.

Mutual fund schemes that declare dividends regularly are suitable for investors who:

  1. are looking for regular income or
  2. have a low-risk appetite

Taxation of mutual fund dividends

From 1st April 2020, the dividends received by unitholders are taxable in their hands. The dividend amount has to be added to the overall income of the assessee and taxed as per their income tax slab. The dividends are subject to a TDS of 10% if the dividend payable exceeds Rs. 5,000 in a financial year. If the unitholder has not submitted their PAN, then the TDS will be deducted at 20%.

To avail of the TDS exemption, investors who are senior citizens (age above 60 years) need to submit Form 15H. All other investors need to submit Form 15G to avail of the TDS exemption. However, you still need to add the dividend to your overall income and pay tax (if required) on it as per your income tax slab.

The investor needs to submit Form 15h/15G every financial year, preferably at the start of the year. The form can be submitted online or at the office of the mutual fund.

Alternatives to dividend option

Mutual fund schemes offer 3 options to investors. These include:

  1. Dividend option
  2. Dividend reinvestment option and
  3. Growth option

We have seen how the dividend option works. In the dividend reinvestment option, the scheme reinvests the dividend amount on behalf of the unitholder and allots equivalent scheme units to the unitholder.

For long-term financial goals like a child’s higher education or retirement, the investor should opt for the growth option.

The growth option enhances your returns with the power of compounding.

When the investor opts for the growth option, the profits made by the mutual fund scheme are re-invested on behalf of the investor. The re-invested profit also earns returns for the investor. In the long run, the profits re-invested from time to time and the returns earned on it benefit from compounding. As a result, the overall returns given by the growth option will be higher than the dividend option for the same mutual fund scheme.

The underlying securities portfolio of the scheme remains the same, irrespective of whether you opt for the growth option or dividend option. The difference is just with regards to how the scheme profits are utilised. In the dividend option, they are distributed to unitholders. In the growth option, they are re-invested on behalf of the unitholders. As a result, the NAV of the growth option will always be higher than the dividend option.

As an investor, if you are looking for regular income, then you should opt for the dividend option. On the other hand, if you don’t need regular income and are looking for potentially high returns, you should opt for the growth option in the long run.

Renaming of dividend options in mutual fund schemes

The capital market regulator, Securities and Exchange Board of India (SEBI), has directed mutual fund houses to rename the dividend options in mutual fund schemes as follows:

  1. Dividend option to be renamed as “Payout of Income Distribution cum capital withdrawal option.”
  2. Dividend reinvestment option to be renamed as “Reinvestment of Income Distribution cum capital withdrawal option.”

The renaming of dividend options is effective from 1st April 2021

Investing for financial goals with Glide Invest platform

As an investor, whether you wish to invest in a mutual fund scheme’s dividend option or a growth option, you need to identify a suitable mutual fund scheme. The Glide Invest platform can guide you to identify the suitable mutual fund schemes that suit your needs. On the Glide Invest platform, you will also get guidance for:

  1. A personalised risk profile assessment
  2. Identifying your financial goals
  3. Appropriate asset allocation
  4. Making a financial plan for each goal
  5. Automating the financial plan
  6. Review and analysis of your financial plan 
  7. Hand holding you till your financial goals are achieved.

To start investing towards your financial goals, download the Glide Invest App now from Google Play Store or Apple App Store and get started.

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