To lure investor, mutual funds come out with advertisements from time to time publicising dividend payout by their schemes to lure investors. If you are looking at investing in mutual funds, should you consider the dividend payout as a good-enough parameter to judge whether to invest?
Mutual fund experts say that dividend declared by mutual funds should not be a major criterion on choosing a fund. In fact, they say that taking a mutual fund investment decision based on the dividend record may lead to wealth erosion.
“Many investors do not understand the differences between the dividends by mutual funds and companies. This leads them to investing in mutual funds which are declaring dividends without realising that the utility of dividends in mutual funds is completely different as a tool of profit-booking or income-generation and this should not be the basis of selection of a mutual fund. This leads to various investors taking an incorrect decision on fund selection which is harmful to the overall portfolio of investors,” Manoj Nagpal, CEO, Outlook Asia Capital said.
S Sridharan, head, financial planning and advisory, Fundsindia.com agrees. “Dividends are not assured. Thus, the dividend assured this year by a mutual fund may not be continued on a yearly basis. The investors who invests in mutual funds should always look out for growth option where compounding happens. When the investor opts for dividend, the money tree may not grow as the profits in the funds are taken out as dividends,” Sridharan told FeMoney.
Nagpal feels only those investors who want income-generation should opt for dividend. “On the record date of the dividend, the NAV of the mutual fund will fall by the exact amount of the dividend paid to investor plus the dividend distribution tax (DDT), if it is applicable. Thus, dividends paid by mutual funds are an accounting entry only and should be used by investors looking at income generation,” he said.
Here’s how dividend payout by mutual funds works:
Explaining how dividend distribution happens in a mutual fund, Sridharan pointed out dividends are declared by the asset management companies (AMCs) based on their accumulated profit on the funds. At times, they may declare dividend even if there was no profit. In such cases, the value of investments would go down from the original investments.
In fact, dividends are declared by reducing the NAV. Assuming that the dividend declaring fund’s NAV is Rs15 and if they declare a dividend of 10 per cent, the NAV of the fund would be down by Rs 1 per unit. The dividend percentage would always be calculated on the base NAV which is Rs 10 for all the funds. After the declaration of dividend in the above case, the NAV of the fund would be Rs14 as they have declared Rs.1 as dividend.