{"id":153,"date":"2018-08-19T15:34:59","date_gmt":"2018-08-19T10:04:59","guid":{"rendered":"https:\/\/srinivesh.in\/blog\/?p=153"},"modified":"2019-02-04T12:04:55","modified_gmt":"2019-02-04T06:34:55","slug":"mutual-fund-dividends-just-say-no","status":"publish","type":"post","link":"https:\/\/srinivesh.in\/blog\/mutual-fund-dividends-just-say-no\/","title":{"rendered":"Mutual Fund Dividends – Just say NO"},"content":{"rendered":"

Summary<\/h2>\n

All mutual funds in India have different ‘plans’ – they have a growth plan and a variety of dividend plans. Unlike dividends from stocks, mutual fund dividends are paid out from the fund corpus itself – any dividend then decreases the Net Asset Value of the dividend plan. While mutual fund\u00a0 dividends are tax-free in the hands of the investors, they are subject to Dividend Distribution Tax (DDT). In almost all cases, the combination of DDT and the benevolent taxation on capital gains makes mutual fund dividends a bad choice.\u00a0 So in almost all cases, an investor should use only the growth plan and use redemption’s as required.\u00a0 This article is applicable to India. The suggestion would be unsuitable for other countries – particularly countries like the USA which have legal requirements for dividends from mutual funds.<\/p>\n

What are Dividend Plans<\/h2>\n

A mutual fund invests the pool of money in a basket of securities. This becomes the corpus of the fund.\u00a0 Interest payments, dividend payments, etc. from the securities are added to the corpus of the fund and this increases the Net Asset Value (NAV) of the units. All the plans of the mutual funds – Growth plan, Dividend plan, Dividend Reinvestment plan – have the same underlying corpus.\u00a0 For Dividend plans, a part of the increase in corpus is paid out in the form of ‘dividends’.\u00a0 This payout results in a corresponding decrease in the NAV of the dividend plan. Here is a simplistic view.<\/p>\n

\"dividend_flow.png\"<\/p>\n

A real-life example of a popular dividend paying fund – HDFC Hybrid Equity – is below. The chart is courtesy mutalfundsindia.com<\/p>\n

\"hdfc_hybrid_equity.JPG\"<\/h2>\n

The chart plots the NAV of the plans for the last five years, with a base of 100. The red line is for the growth plans and the blue line is for the dividend plan. It is evident that the NAV of the growth plan is consistently higher than that of the dividend plan.<\/p>\n

Difference between Growth plan and Dividend plan<\/h2>\n

Let us think of an ideal world where the following assumptions hold:<\/p>\n

    \n
  1. Tax treatment of different classes of income is the same<\/li>\n
  2. There are no costs and\/or taxes on dividends<\/li>\n
  3. There are no exit loads<\/li>\n<\/ol>\n

    In this world, there would be no effective difference between the two plans. In the above picture, the investor could buy one unit each in the dividend plan and growth plan and sell both units after the dividend is received.\u00a0 The net gain of the investor would be Rs 2 each in both plans. For the growth plan, the gain is all in capital gains = 12 – 10, while in the dividend plan, the gain is capital gain = 11 -10, plus Rs 1 of dividend. Alternatively the investor can re-invest the dividend of Rs 1 in the dividend plan again and continue holding them; she would then have Rs 12 worth of investments in both the plans. She would have one unit worth Rs 12 each in the growth plan and approximately 1.091 unit worth Rs 11 each in the dividend plan.\u00a0 (This is what the dividend reinvestment plan does.)<\/p>\n

    However we don’t live in an ideal world. The next section describes the tax treatment as of 2018.<\/p>\n

    Tax treatment of dividends and capital gains<\/h2>\n

    The current tax rules differentiate between equity mutual funds and all other funds for the following factors:<\/p>\n