Dividends! Dividends! Dividends!
Many investors today are falling into the trap of monthly dividend created by asset managers. It has become the biggest miss-selling practice in the MF history. Thousands of crores have flown into such monthly dividend plans of Aggressive hybrid funds (Erstwhile balanced funds) that are being sold with a guaranteed monthly dividend of 1% on the investment amount.
Why I say it is a trap:
- Dividend is miss-understood as additional money that comes to investor as profit, however, dividend in mutual fund is nothing but distribution of income from ones own investments. DIVIDEND IS NOT SOMETHING WHICH IS ADDITIONAL PROFIT!
- Dividends are not guaranteed – dividends are declared at the discretion of the mutual fund and is depended on many factors owing to which a mutual funds can skip declaring dividends. (Don’t want to get into technicalities of this as it may not be relevant at the moment)
- Dividends can erode your principal amount. If dividend is declared by the MF when the fund returns are negative, it is paid from your principal. Eg: You invested Rs. 10,000 and market value of your investment falls to Rs. 9,500 due to market conditions, a Rs. 500 dividend paid in such a scenario erodes your principal investment by Rs. 500 and now your current value becomes Rs. 9,000.
- Dividends are taxable at the rate of 10%. So this becomes a double whammy when your own capital is paid back as dividends and you have to pay 10% tax on that. This is suicidal!
In this backdrop it is indeed brave for an asset manager to come up with something which is investor friendly and promotes best practice. Motilal Oswal AMC in its latest New Fund Offering – Motilal Oswal Equity hybrid Fund is promoting cash flow feature instead of monthly dividend. In fact the fund doesn’t have a dividend option. While I will not talk about the New Fund as it is not something unique and if someone wants to invest they may do so, I would like to highlight the cash flow option which can be availed in this or in their existing Dynamic Equity Fund for consistent cash flow needs.
What is this Cash Flow Option?
- It is a simple systematic withdrawal plan that offers to give you back some amount from your investments at fixed intervals.
- This allows you to benefit the consistent cash flows as per your need and you don’t have to depend on the mercy of Mutual Fund to declare tax inefficient dividends.
- The facility is better than monthly dividend as it is tax efficient than dividend option. Read details here (they have explained why Cash Flow Option (SWP) vs Dividend well, saved my time)
- You can avail this option in your existing mutual funds as well. All mutual funds have SWP option available, only thing is they don’t promote the way Motilal Oswal MF is promoting and being responsible.
- One technical aspect needs a mention – SWP is more tax efficient in the initial years – upto 10 years. As the corpus grow over years effective tax rate increases. However, due to 1 lakh exemption that is available on Long term gains form equities, this option will always be tax efficient than dividends. So you don’t need to worry!
So don’t wait anymore, shut down that inefficient monthly dividend option tomorrow morning and go for a Systematic Withdrawal Plan – aka – Cash Flow Plan. Heartiest congratulations to team Motilal Oswal MF for this brave step.
Secret: Opting Systematic withdrawal plan instead of dividend plan can add up to 0.5% more returns to your kitty in the long term. Hope you know how much more you make by just 0.5% additional return – Approx Rs. 1 lakh more in 20 years on Rs. 10 lakh investment. (This is an approximate calculation based on tax saved in SWP initially and compounded over 20 years)