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Many investors opt for the dividend options of Mutual funds as it gives them intermittent cash flows, which comes handy in meeting their regular expenses. This article talks about Growth and Dividend options of Mutual Funds, How does a Mutual Fund declare a dividend? What are Record Date, Face Value of Fund, Tax treatment of Dividends, Dividend Distribution Tax, Switching between Mutual Funds.

Growth and Dividend Options of Mutual Funds

Mutual fund schemes offer three options while investing: Growth, Dividend Payout, and Dividend Reinvestment.
  • Under the Dividend payout option, the scheme distributes realised profits to investors as dividends. This option is useful to investors looking for periodic income from their mutual fund investments.
  • Dividend reinvestment option does not distribute the dividends to investors, the dividend is declared, but not physically paid out. Instead, it is reinvested back into the scheme.and the additional units are issued.  These additional units are treated like a fresh purchase.
  • The Growth option reinvests the profits back into the scheme and it is the ideal option for investors who are looking to create a corpus for long-term goals.

Same fund manager manages the different options. The investment portfolio that will be handled by the fund manager is same, irrespective of which option one chooses. So the choice of fund will not modify the performance of Mutual Funds.

The choices are accounting entries that the fund makes to suit the needs of investors who may require dividend payouts. The following table shows difference between Growth, Dividend Reinvestment, and Dividend Payout options. Our article Growth and Dividend Option in Mutual Funds

Description Growth Dividend Reinvestment Option Dividend Payout Option
Dividend Received No Yes No
Dividend distribution tax(DDT) No Yes for schemes with equity <65% Yes for schemes with equity <65%
NAV Change No Declines to the extent of dividend and DDT Declines to the extent of dividend and DDT
Number of Units No change Increase in no of units No change

What is Dividend?

 A dividend is a payment made by a corporation to its shareholders, usually as a distribution of profits. When a corporation earns a profit or surplus, it can either re-invest it in the business, or it can distribute it to shareholders. A corporation may retain a portion of its earnings and pay the remainder as a dividend
Typically dividend is associated with stocks. A dividend is a portion of a company’s earnings that is returned to shareholders. Dividends provide an added incentive to own stock in stable companies. For a lot of stock investors, dividend income means a lot. With stocks, regular dividends (in combination with other key factors like revenue and profit growth, cash flows) speak for the company’s solid fundamentals.
But with Mutual Funds dividends are different. A mutual fund does not declare a dividend from its own pocket but is from profit. Dividend in a mutual fund is your own money coming back to you. The exact amount of dividend that is declared will be reduced from the Net Asset Value (NAV), so effectively your net wealth does not change.
Suppose you hold 1,000 mutual fund units with a NAV of Rs 20 and the fund house declares a dividend of Rs 2 per unit. Since the dividend is coming directly from the NAV, the NAV will fall by Rs 2 to Rs 18. You would get 1000 *2 = 2000 Rs

How does a Mutual Fund declare a dividend?

A mutual fund scheme can declare dividends only from the realised profits in its portfolio. Realised profits are the gains made by the fund manager from instruments by selling them and booking profits or when he receives dividend or interest (for debt funds) from the instruments the scheme holds.

Unrealised profits or paper profit from the instruments held cannot be used to pay dividends. These profits are added to the NAV. Some part of this can be declared as dividend depending on the fund manager. Alternatively, the fund manager could also deploy this money back in buying stocks or debt instruments in line with the scheme objectives.

At what frequency can an investor expect a dividend from a mutual fund scheme?

Schemes can announce dividend daily, monthly, quarterly or annually as the case may be. For example, many hybrid funds or monthly income plans endeavor to give a monthly dividend to their unit holders. However, the dividends are not certain and the amount is also not fixed.

Usually, under the dividend option, the NAV (net asset value) is not allowed to grow higher and whenever it reaches a certain level, the fund house pays out dividends. Assume you have invested in a fund at the NAV of  Rs14 and opted for dividend option. The scheme performs and, after the appreciation the NAV reaches Rs 16. The fund house may decide to pay out Rs 2 as the dividend. So you receive Rs 2 as dividend and simultaneously the NAV will fall back to Rs 14.

Face Value of Mutual Fund

In case, of shares Face Value is the initial value of the share with which the initial value of the company’s capital is envisaged. For example, if a company is envisaged to have an initial capital of Rs 10 lakh divided into shares of Rs 10 each, Rs 10 is the Face Value of the share & the value of initial equity is Rs 10 lakh.  Market value is the current price at which the shares of a company change hands. Face Value changes when the company splits the stock to half the stock price by doubling the number of shares. From an  investor’s point of view, it has no bearing on the actual value of the company. Dividends of Stocks are declared on Face Value of share and not market price.

For Mutual Funds, like Shares, Face Value is the initial value at which Mutual Fund lists after New Fund Offer (NFO) and it is usually Rs 10. But NAV of a Mutual fund is the current price at which the units of a mutual fund change hands. From an investor’s point of view, it has no bearing on the actual value of the Mutual Fund. Dividends of Mutual Funds are declared on Face Value of Mutual Fund and not NAV. For ex, if mutual fund declares a dividend of 20% of face value then taking Face Value of Rs 10 Dividend works out to be Rs 2 per unit. The performance of a scheme is reflected in its net asset value (NAV) which is disclosed on daily basis in case of open-ended schemes and on weekly basis in case of close-ended schemes

Terms associated with Dividend Options of Mutual Funds

Record Date: is the date when the mutual fund company records who its unitholders are. The unitholders of record will receive the fund’s income dividend

Ex-Dividend Date: The date on which a fund’s Net Asset Value (NAV) will fall by an amount equal to the dividend. It is usually a few days after the record date. NAV of the Mutual Fund falls on that date.

Dividend Distribution Tax (DDT): dividends are not taxable at the hands of investors but Mutual Fund company has to pay Dividend Distribution Tax.

Dividend amount:  Dividend is declared per unit. So dividend amount that one gets is by multiplying number of units with dividend amount. Dividends of Mutual Funds are declared on Face Value of Mutual Fund and not NAV.

Dividend History is the past track record of dividends declared by a fund. It is easier to declare dividends when markets are doing fine, but you should always check if the fund has performed equally well across market cycles, and if it has declared similar dividend rates during the ‘bear’ phase of the market. This will help you gauge the consistency of a mutual fund scheme fund to an extent.

  • Is One entitled to dividend payout if one buys the fund on ex-date itself?
  • A: No, the investor will only get the dividend if he/she invests before or on the record date of the dividend.
  • Is One entitled to dividend payout if one buys the fund one day before ex-date? 
  • A: Yes.
  • Is One entitled to dividend payout if one sells the fund on or after ex-date?
  • A: Yes.

NAV And Dividend Options of Mutual Funds

Suppose Shyam invested Rs 2000 to buy a Mutual Fund at NAV of Rs 20. The Number of units Shyam will get are Investment Amount / NAV of the Fund on the Allotment Date. So Shyam gets  2000/20=100 units.

After a year, NAV of Mutual Fund goes to Rs 25. Now mutual fund declares a dividend of 20% of face value which mostly is Rs 10 hence Rs 2 per unit. NAV of Mutual Fund becomes 25-2 =23 per unit.

  • Shyam will get Rs 2*100 = 200 Rs as Dividend if he chose Dividend Payout,
  • Shyam will get (2*100)/23 = 66.67 new units if he chose Dividend Reinvestment.
  • Shyam will not get anything if he chose Growth Option but NAV will remain Rs 25.

How to find Dividend History of Mutual Funds?

Dividend History is the past track record of dividends declared by a fund. It is easier to declare dividends when markets are doing fine, but you should always check if the fund has performed equally well across market cycles, and if it has declared similar dividend rates during the ‘bear’ phase of the market. This will help you gauge the consistency of a mutual fund scheme fund to an extent.

Fund Houses have Dividend History of the funds. Many websites like EconomicTimes, MoneyControl, Value reserachOnline, Advisor Khoj have information about Dividends declared.  In moneycontrol.com, find the name of the Mutual Fund scheme and on Left Hand Side click on Dividend Historyshown in the image below. You will see entire Dividend History of the fund since its inception. For example For HDFC Prudence Dividend History from moneycontrol  shown in the image below.

Dividend History of Mutual Funds

Dividend History of Mutual Funds

What is the tax treatment of Dividends in Mutual funds?

There are two kinds of income on which a person may be required to pay tax on Mutual Funds:

  • Dividend income 
  • Capital gains

Under a growth fund, all income will be in the form of capital gains (since no dividend is paid out).

Under the dividend payout/dividend re-investment option, income will be in form of both dividend and capital gains.

Dividends received from all mutual funds are tax-free in the hands of the investors. However, for debt funds the fund house pays a dividend distribution tax of 28.84% which includes surcharge and cess.For equity mutual funds there is no dividend distribution tax.

Though Dividends are not taxable in hands of investors they need to be shown in the Income Tax Return Form as Exempt Income under Dividend Income as shown in Image below. Our article Exempt Income and Income Tax Return explains it in detail.

Dividends shown in ITR, Dividend Options of Mutual Funds

Dividends from Mutual Funds to be shown in ITR

Dividend distribution Tax and Mutual Funds

Dividends are not taxable at the hands of investors (not directly) but Mutual Fund companies have to pay Dividend distribution tax or DDT based on the type of scheme and the NAV will come down that much. For example, if you hold a fund with a NAV of Rs. 22, and it pay out Rs. 2 per unit as the dividend, it will pay a DDT of Rs. 0.5 (25% of dividend) and the NAV will fall down to Rs. 9.5. Effectively, that tax is paid by you.

  • Equity mutual funds (>65% in equity ) do not pay DDT.
  • From Jun 1 2013 DDT applicable for debt funds or rather non-equity funds was increased from 12.5 per cent to 25 per cent for individuals and HUFs. DDT applicable to any person other than an individual or HUF i.e. a firm, or a company, continues to be 30 per cent.
  • From October 1st 2014, the way in which DDT is calculated has been revised. Now DDT will be gross dividend and not net dividend.
Please find below an illustration on dividend payment considering the change in DDT computation where for easy understanding, we have assumed DDT@25%*:
Prior to Budget 2014-15 As per Finance (No. 2) Act 2014 (effective date Oct 1st 2014)
A.  Dividend declared (in Rs).   100  Dividend declared (in Rs).   100
B.  Net Dividend (in Rs.) B=A/(1+DDT)   80  Net Dividend (in Rs.) B=(A-C)   75
C.  DDT (25%) C=(A-B) or Bx25%   20  DDT (25%) C=(AxDDT)   25

Capital Gain in Mutual Funds

There are 2 types of capital gains Short Term Capital Gain and Long Term Capital Gain, based on how long the asset was held. Our article Tax and Mutual Funds discusses it in detail.

Immovable property and unlisted shares become long-term assets when held for more than 36 months; in case of listed shares, the period of holding is just 12 months for the categorisation. Our article Basics of Capital Gain explains Capital Gain in detail. Our article Cost Inflation Index,Indexation and Long Term Capital Gains explains how to use indexation for Long term capital Gains. Following table shows the Short Term Capital and Long Term Capital Gains for Debt and Equity Mutual Funds.

Type of Asset Short Term Capital Gain Long Term Capital Gain Tax on Short Term CG Tax on Long Term CG
Debt Mutual Fund Before Aug 2014: Selling before 1 yearAfter Aug

After Aug 2014:Selling before 3 year

Before Aug 2014: Selling after 1 yearAfter Aug

After Aug 2014:Selling after 3 year

Added to income and taxed as per tax slab. Before Aug 2014 If indexation used 20%, Without indexation 10%After Aug 2014 If indexation used 20%

After Aug 2014 If indexation used 20%

Equity Mutual Funds with STT paid Selling before 1 year Selling after 1 year Taxed at 15% NIL

Switching between Dividend Options of Mutual Funds 

Switching from dividend to growth plan or from growth to dividend would be taken as redemption from the existing scheme and fresh purchase in the new plan because both plans have different Net Asset Values (NAVs). The switch would also attract exit load (if applicable) and short-term or long-term capital gains tax based on the holding period. You just have to fill up a form and the procedure normally takes 24 hours to complete

Any change from Dividend Payout to Reinvest (or vice-versa) can be done by giving a simple written request or filling transaction slip. It has no implications on the number of units and future dividends would be reinvested(or paid out).

Our article Switching of Mutual Funds discusses it in detail.

Related Posts:

Financial planners recommend dividend option for conservative investors in equity for those who are risk averse and those who need some cash flows. For those looking to build wealth over the long term through equity mutual fund systematic investment plan (SIP) it is advisable to opt for the growth option.This is because the compounding benefit is lost when the dividend is paid unless the amount is invested immediately in a higher than equity yielding asset. Do you invest in Dividend Option? Which one Dividend Payout or Reinvestment? Why do you invest in Dividend options.

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