How dividends are handled by mutual funds?
How dividends are handled by mutual funds?
Equity Mutual Funds primarily invest in stocks of various companies. So from time to time, the Mutual Fund can receive dividends from one or more of the companies it has invested in.
The dividends received by a Mutual Fund do benefit investors even though the money is not directly transferred to the investor’s bank account. Let’s see how
As the money is received, it is held as cash or in highly liquid low-risk debt instruments (sometimes called cash equivalents). Because of this extra cash, the AUM goes up, and you will also see an impact on NAV (it goes up) due to these dividends coming in.
But this is temporary parking of the dividends. Then, as the fund manager finds the right opportunity, he takes these dividend payouts to invest so that this money grows too.
This process of how dividends get used is followed even if you have a Dividend Plan of a fund. This can be quite confusing for most investors of the jargon. However, the dividend plans payout is not a dividend received from a company but a part of returns generated by the fund. Dividends from a company can be part of those generated returns, but they are not the only component of what is paid out.
So when a company announces dividend, the dividend paid by the company in the portfolio of a mutual fund scheme gets immediately reflected in the NAV. This will increase the nav of the fund. But it is not necessary that a mutual fund would pay you a dividend (in case of dividend option) when it gets a dividend from some companies in its portfolio.
The fund house pays dividend on its discretion and may also distribute it without receiving any, say when it has realised some profit from the shares in its portfolio. However, as soon as the dividend is paid by a mutual fund scheme, the NAV gets reduced by the same amount. It is like getting a part of your money back. Unlike a dividend from equity shares, dividend from mutual funds is completely an arithmetic adjustment.
There is one key advantage here.
When a mf receives dividend, it is not taxed. But as an individual investor, dividend is taxable in your hands.
Say, you own 1000 shares of company XYZ directly and also through the MF (just assume this for now) and it announces 50 rupees dividend per shares,
a. As an individual investor, you will receive 50,000 rupees as dividend. But since this is taxable in your hands and assuming you are in 30% tax bracket, you will get only 35K.
b. But if you hold same amount of shares through mf, the dividend received by the fund is not taxable. So the fund house will get whole 50K and can reinvest the same.
So, you can easily spot the difference in returns. This 15K amount may seem low, but it will happen again and again over the years, which will result in very significant difference over the years.
So by owing stocks directly, you are losing out huge amount of money in the form of taxes unnecessarily. So unless you are really good investor who can beat the market easily, holding stocks directly reduces your returns
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