Should you chase dividend funds?

Srikala Bhashyam March is a time when mutual funds get into overdrive with their dividend announcements. With the financial year coming to an end and the last 12 months being one of the surprisingly good years for the equity markets, the news flow on the dividend front hasn't been surprising.

The news flash, of course has its desired effect. I have seen many investors looking to invest in tax saving schemes, choosing the scheme based on the dividend flash! The investor tends to get excited when he receives some money immediately after investing!

Is equity trading bad for your financial health?

The question is whether the investor should really get excited? The answer is no. Unlike equity stocks where is no direct correlation between the price of stock and dividend payout, the impact of dividend is far more direct in the case of mutual funds. So, how does it really work?

If a mutual fund declares a dividend of Rs 4 per unit against an NAV of Rs 15, the later falls down to the same extent after the declaration of dividend. On the other hand, the stock price may or may not fall once the stock becomes ex-dividend. So, the excitement of a mutual fund investor, to that extent is unwarranted.

Are MIPs of mutual funds a safe bet?

In fact, he doesn't miss much if he buys the units after the dividend record date, as he will be investing at a lower NAV. So decision to invest in an MF scheme need not be dictated by the dividend announcement.

In fact, one of the biggest concerns for investors is whether growth or dividend offers better returns. The answer is both offer similar returns with very marginal difference. Dividend allows indirect profit booking and hence should not be considered by those who prefer capital appreciation.

Remember the lessons learnt from the gloom

I wouldn't recommend dividend option to those who are not aware of their inflows and outflows from bank account. An income of a few thousands of rupees might rob the investor of good capital appreciation. Take the case of tax saving scheme. A dividend income of Rs 20,000 over a period of three years could result in a much higher capital appreciation in a growth plan.

Having said that dividend plans are not irrelevant for all. They make a good sense for those looking at regular cash flow from their investments. In fact, senior citizens or those depending on regular tax efficient schemes should opt for dividend schemes as they ensure regular cash flow.

What is best? SIP or lump sum

Even HNIs can park a portion of their corpus in dividend payout schemes and use the income for re-investment into equity. In such cases, dividend transfer plans work better and the money should be invested into a debt fund.

But the biggest difference between the dividend from stock and mutual fund is that the latter is far more cost effective. Companies, which dole out higher dividends don't carry small price tag, which in turn means the actual yield is far lower.

On the other hand, the NAVs of MF schemes still ensure good returns though one faces the risk of capital erosion in the short term. Also, very few equity schemes follow the practice of paying dividends consistently. This could make it unattractive for an investor, dependent on dividend income. But the same is compensated by growth in capital appreciation.

Strategies for SIP investment

Dividend facts:

The NAV of a scheme falls proportionally after the dividend payout
Equity MFs may or may not declare dividends on annual basis
Dividend is tax free in the hands of investors but carry dividend distribution tax
Not much significant difference in the returns of dividend and growth plans

The author can be reached at srikala.bhashyam@gmail.com

The views expressed in the article are the author's and not of Sify.com