Contents
Introduction
Dividend mutual funds are a type of stock mutual funds that invests in those companies which pay dividends. Dividends are profits that companies give to their stock shareholders. Most investors buying dividend mutual funds are usually looking for a source of income. The investor would like steady and reliable payments from their mutual fund investment.
Dividend mutual funds are the best option for retired investors. Dividend mutual funds also tend to be less risky than other funds, such as growth stock mutual funds. A Dividend is actually a distribution of earnings from a stock or a Mutual Fund. In Mutual Funds schemes, dividends are given when the fund has booked profits on the sale of securities in its portfolio.
In this article, we will be exploring the dividend mutual funds in detail.
Meaning of Dividend Mutual funds
As per regulation, a fund can declare dividends only from the gains it has made from the sale of securities in the portfolio, or through any current income in the form of interest or dividends. Such gains are transferred to a Dividend Equalization Reserve, and at the discretion of the trustees, a dividend is declared.
Dividends are always calculated as a percentage of the scheme’s face value, and not the NAV. However, published in the form of an absolute number (notice for reference attached). For example, if the Face Value per unit is INR 10 and the dividend rate is 20%, then every investor in the dividend option gets INR 2 as a dividend. However, after dividend, the NAV of the scheme falls by an equivalent amount. Investors in the growth option are not entitled to the dividend, and there is no change in the NAV of the growth option.
Dividends from Mutual Funds scheme, while being tax-free in the hands of the investor, have a Dividend Distribution Tax (DDT) deducted at source. Also, read on how tax is charged on mutual funds.
When dividends are paid to investors
The Asset Management Company chooses either to pay dividends daily, monthly, quarterly or annually. However, this varies from one scheme to another. Even though most dividend mutual funds are not able to pay dividends and stick to their respective mandate. Dividends are never guaranteed. The amount given as dividend is not a fixed one. That is, as soon as the NAV reaches a specified level, the fund house will pay out the dividends. An investor must also understand that under the dividend option, the Net Asset Value is not growing higher.
As against Growth funds in which dividends would be paid out to purchase more shares in the fund. This way cash is not paid out to the investor when profits are earned on the stocks in the fund. Instead, cash is automatically used by the fund’s administrators to buy more fund units on behalf of the investors and transfer them to individual investors’ accounts.
Tax implications of Dividend Mutual Funds
Dividends coming from every mutual fund is tax-free. When in the hands of the investors. However, a fund house pays a dividend distribution tax (DDT) of 28.84% for debt mutual funds. This includes surcharge and cess. On the other hand, in equity mutual funds, there is no DDT. For investors who do not want to take a risk in investments. Also, the others who are in need of regular good cash flow, the dividend option in equity funds is quite suited for them. And there is no DDT on equities.
Advantages of Dividend Mutual Funds
Dividends can be regarded as a source of income. They can be used for buying more shares of the mutual funds. Most investors who buy dividend mutual funds are usually looking for a source of income.
In most cases, because of the income-generating nature, dividend mutual funds are best-suited for the retired investors. Dividend mutual funds also tend to be less prone to risk than other types of funds, such as growth stock mutual funds.
Disadvantages of Dividend Mutual Funds
Starting this year, new taxation rules stated that equity fund dividends also lead to investors paying more tax than they should. If a person has opted for the dividend option of a fund, you are almost certainly paying needless tax.
When companies make a profit, they re-invest some of it back in the business and distribute the rest to shareholders. Obviously, the management of the company has a choice in the matter. It’s up to them to decide how much dividend is to distribute. Although, there are plenty of companies that distribute very little or none of the profits as dividends, for a variety of reasons.
These funds actually destroy your money due to the tax on dividends. There’s a total of 10% tax on both long-term capital gains and dividend. However, the tax implemented on capital gains comes into play only when you actually sell your investment. The tax gets deducted by the mutual funds at source every time a dividend is paid out or reinvested.
To overcome the disadvantage of Dividend Mutual funds and still receive income on a regular basis the Systematic Withdrawal Plan (SWP) option may be used by investors. In SWP, the gains will still be taxed and therefore may not help much in reducing tax liability.
Conclusion
Investors can go for growth or dividend option on the basis of their investment goals. So, people who want to grow wealth in the long term, usually go for growth option – this is because the compounding benefit is lost when the AMC pays you dividends.
For any service related to a mutual fund, one can contact with WealthBucket. You can pick from multiple mutual fund services options, Having short term mutual funds, liquid mutual funds, debt mutual funds, equity mutual funds, and income funds and many more. Why wait and think? Just log into the website.
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