PERSONAL FINANCE
Investors’ belief that dividend income is over and above the returns of the scheme is incorrect
The issue of dividend v/s growth option in equity mutual funds is still widely misunderstood leading to sub-optimal investment decisions by individuals.
Investors' belief that dividend income is over and above the returns of the scheme is incorrect. In growth option the same amount is part of the portfolio and compounds to a higher Net Asset Value (NAV) leading to higher portfolio value (reason why NAVs of growth and dividend plan for the same scheme are different).
Let us look at few other aspects around the topic of dividend v/s growth during scheme selection for equity and equity oriented funds.
There were two primary reasons that made investors consider dividend option over growth until last year. Dividend income being tax-free was the first and regular cash flows from dividend for defined goals was the other reason. Let's evaluate both these reasons in current context
With introduction of 10% tax on dividend distributed by equity schemes in last year's budget, the first reason is no longer valid.
Long-term capital gains (LTCG) tax is now not only at par with tax on dividend income, but also has a slight advantage of being tax-free for the first Rs 1 lakh.
Also, the slight disadvantage of short-term capital gains at 15% being 5% higher than tax on dividend income, is of little significance as most investors invest in equities for at least more than a year and do not expect to receive dividends immediately.
The two other small, yet meaningful advantages, for choosing growth option over dividend option are -
A) Chances of offsetting LTCG tax against long-term or short-term losses from other investments. This option is not available under dividend plan, as tax is deducted by the scheme at the time of distribution.
B) Timing of deduction of the tax. While 10% dividend distribution tax is paid immediately on payout, capital gains tax is paid as per advance tax deadlines, leading to higher compounding of this tax component, which remains part of the portfolio. This also makes dividend reinvestment option in equity schemes completely worthless.
Dividends are distributed from reserves and are neither guaranteed for a defined amount nor fixed for specific dates. Hence, they do not serve the purpose of a fixed amount needed at defined intervals for specific goals (unfortunately there are some bad practices where past dividend history of a scheme is highlighted to stress on this feature to gullible investors, who would be caught by surprise if in future dividends are discontinued, lowered or paid at irregular frequencies, when scheme reserves or market conditions do not support past dividend trends).
A systematic withdrawal plan (SWP) in growth option perfectly serves this need for an investor, where he can choose the amount and date for periodic cash flows as per his requirements, without being constrained by scheme limitations.
While the above arguments establish the advantages of growth v/s dividend option for equity schemes, the same choice in debt option requires further considerations around some more variables like holding period, individuals' personal tax rate slab, etc.
For now, armed with the facts stated above, equity investors should re-look at their portfolios and ask their advisors on the rationale for their choices and recommendations and implement corrections if need be.
The author is managing partner and head - Family Office of ASK Wealth Advisors. The views and opinions expressed in this article are personal
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