Growth option or dividend payout? Weigh pros & cons before taking pick

By: | Updated: August 4, 2015 5:24 PM

Strong inflows into equity mutual funds indicate a shift in the nature of Indian households’ savings from physical to financial assets. Non-productive physical assets like gold continue to lose their allure

bse sensexStrong inflows into equity mutual funds indicate a shift in the nature of Indian households’ savings from physical to financial assets. (Picture for representation only)

Investments in mutual funds are gathering momentum. Inflows into equity schemes of domestic MFs over the last 12 months were greater than that in the past decade. Despite weakening sentiment over near-term prospects of the Indian market, equity mutual funds have posted positive inflows for 14 straight months now.

Strong inflows into equity mutual funds indicate a shift in the nature of Indian households’ savings from physical to financial assets. Non-productive physical assets like gold continue to lose their allure. In this backdrop, it’s important for asset management companies to sustain investor confidence. The regulator, too, needs to do its bit in this regard.

A case in point is discontinuing the option of dividend reinvestment into equity-linked savings schemes (ELSS).

As we all know, no two investors are identical. While a few seek the growth option, others are happy with dividends, if possible, at regular intervals. Predictable cash flow in terms of interest at fixed intervals are offered by banks and companies, which is an attraction for them, as there is predictability and certainty.

Many investors prefer predictability in income and this is also true for their expectation of dividends from mutual funds. The point to note is that fund houses can declare dividends only in accordance with the Securities and Exchange Board of India (Sebi) regulations.

Scheme selection

Typically, for predictable cash flows and certainty of income on a regular basis, fixed-income schemes are the go-to option. The time horizon here is in excess of 3-5 years. So, if one allocates, say, 10% of the corpus into an equity mutual fund scheme, how will the cash flow and returns work out?

For this exercise, we considered a large-cap diversified equity scheme in existence for two decades with an investment period of five years and 50% allocation each to growth and dividend payout options. So, a corpus of R10 lakh was allocated equally between the growth and dividend payout schemes.

Returns: In the growth option, at 14.5% over five years, the investment of R5 lakh swelled to R9.86 lakh. In the dividend payout option, on the other hand, at 13.08%, the investment of R5 lakh grew to R6.35 lakh. However, the dividend distributed during the period was R2.21 lakh.

It’s evident from the above example that the growth option delivers better returns and capital appreciation than the dividend payout option. Also, the return after tax is higher than from other fixed-income products. There is predictability of receipt of income and its quantum.

However, note that the noise between the holding periods is not reflected. And that’s why its important that, as an investor, you are very clear about the holding period of your investments. The draw-downs can have a very negative impact on the investing process. In this exercise, only a part of the corpus was invested in equity mutual funds for the purpose of dividend.

There are other options like Systematic Withdrawal Plan (SWP), which can be used for predictable cash inflows. But when drawdowns happen, the capital appreciation will not be in the same league as in the growth option.

Always keep your investment options simple and look at long-term returns. There are schemes that do offer monthly dividend payouts and these have been consistent over the two-year period. But, again, the payouts are subject to compliance with Sebi norms.

The writer is founder and managing partner of BellWether Advisors LLP

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