We’ve got some bad news for you and we’re going to give it to you without any sugar-coating. We’ll rip the band-aid off in one quick motion. It will hurt, but only momentarily. It’s best to get such tough things out of the way as quickly as possible.
So, here goes.
Remember that cockroach you killed yesterday? Well, cockroaches can live without a head for several weeks. Also, the masks available at your neighbourhood chemist can’t really protect you from air pollution. And yes, mutual fund dividends are not actually dividends.
We’re sorry if the third one came as a shocker. But it’s true. You might be investing in the dividend plans of equity funds for a periodic payout, but what you’re receiving is not an additional income. Equity fund dividends are just a part of your own investments that is redeemed on your behalf and paid out to you.
In investment terminology, dividends are understood to be money that a company pays to its shareholders out of its profits. This is true for stock dividends. But it is not true for mutual fund dividends.
To reiterate, mutual fund dividends are a part of your investments only. For example, if you have Rs 100 invested in a fund and the fund pays you a dividend of Rs 10, then your investment value will come down to Rs 90.
This is how mutual fund dividends work, which is, unfortunately, something that most investors don’t know. They choose the dividend plan of a fund with the intention of earning a regular income.
Well, that was the bad news. Thankfully, we’ve got good news as well.
There are two better ways of generating a periodic income from your investments, instead of investing in a dividend plan.
Equity fund dividends also don’t make sense from the perspective of taxation. They are subject to a dividend distribution tax of 10%, which was introduced in Budget 2018.
By the way, bad news is not always actually bad news. Sometimes, it is just good news waiting to happen. Right?