Dividend Option in MFs

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Mutual Funds Dividend Option

Many investors are putting in money into the dividend option of mutual fund (MF) schemes. Some cash flows from their investments helps them manage their expenses.

What does dividend in a mutual fund mean?

Any mutual fund scheme — be it debt, equity or hybrid — can declare dividends for its unitholders from the realised profits in its portfolio. Realised profits are the gains made from instruments by selling them at a price higher than what they were purchased for or when the securities held in the scheme receive dividend or interest (in the case of debt funds) from the instruments held. As per regulations, unrealised profits from the instruments held cannot be used to pay dividends. These profits are added to the net asset value (NAV). A part of this can be declared as dividend depending on the fund manager. Alternatively, the fund manager also has the option to deploy the money back in buying stocks or debt instruments in line with the scheme objectives.

With what frequency can investors expect a dividend in a mutual fund scheme?

Mutual funds could pay you daily dividend, monthly dividend, quarterly or annual dividends. This could vary from one scheme to another. There is no guarantee of dividend payment, but most of them endeavor to pay dividend and stick to their respective mandate. For example, several liquid and ultra short term funds endeavor to pay a daily dividend, while some equity funds pay quarterly and annual dividends. However, the dividends are not certain and the amount is also not fixed.

Are dividends on MFs taxed?

Dividends from any MF scheme is tax free in the hands of the investors. However, in the case of debt funds, the fund house pays a dividend distribution tax of 28.84% which includes surcharge and cess. In an equity mutual fund, there is no dividend distribution tax.

Who should opt for the dividend option?

Financial planners recommend dividend option for investors who need some cash flows. Those looking to build wealth over the long term through equity mutual fund using SIP, should opt for the growth option.

This is because the compounding benefit is lost when dividend is paid, unless the amount is invested immediately in a higher than equity yielding asset. For those in the highest tax bracket investing for a period less than three years, could opt for the daily dividend option in liquid /ultra-short term funds as the dividend distribution tax is 28.84% compared to their individual tax slab of 30.9%.

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