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    Mutual fund SIPs won't help in this situation and dividend plans are always pointless

    Synopsis

    To the investor, the word dividend brings to mind corporate dividends, which are indicative of how profitable a company is and how much of the profits are being distributed to shareholders. In mutual funds, this is NOT the meaning of the word ‘dividend’.

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    Once upon a time, there were some advantages to dividend plans. But now they serve no purpose.
    By Dhirendra Kumar

    A few days ago, I received an email from a retired person that began with a rather alarming statement: “Kindly do not take my words as criticism but I feel that your opinion regarding SIPs is biased”.

    It is always distressing to see savers come up with reasons for not investing through Systematic Investment Plans (SIPs). However, this email was different. This retiree really had come up with one of the few situations where investing through SIPs into an equity fund doesn’t really confer any additional advantage over a one-shot lump sum investment.

    I will discuss that in a moment but this investor made another point in his email in which he was quite mistaken, and was, in fact, suffering from a common misconception. He complained that I had advised against dividend option of funds. However, he needed a regular monthly income. So how could the growth option be suitable for someone like him?

    This dividend delusion is a common one and arises because mutual fund dividend are not dividends at all. To the investor, the word dividend brings to mind corporate dividends, which are indicative of how profitable a company is and how much of the profits are being distributed to shareholders.

    In mutual funds, this is NOT the meaning of the word ‘dividend’. Instead, they are just a withdrawal from your money. If the value of your investment in a mutual fund is Rs 1 lakh, and then the fund gives you Rs 5,000 dividend, the value of that investment will be reduced to Rs 95,000. In equity funds, there was no such tax till last year. Now, even in an equity fund, there’s a 11.64% tax on dividends paid after that date, including surcharges and cess. You will get Rs 4,418 as dividend while your investment goes down by Rs 5,000.

    However, if you were to just withdraw (redeem) the same amount, then the tax would be lower or may even be zero. The reason is that in case of redemptions too, the tax rate is 10% plus surcharge, chargeable only on the gains part and not the entire amount. Even on the gains, up to Rs 1 lakh of gains are exempt every year. No matter how, the tax is going to be always lower than the dividend option. Thus, it never makes sense to opt for a dividend plan.

    Instead, someone needing a regular income should just redeem the amount every month, either manually or by starting a Systematic Withdrawal Plan (SWP). You’ll pay less tax and for the same amount in hand, eventually make more money because you will withdraw less and thus the money will earn more.

    The logical question that you would now ask is why do dividend plans exist at all? The simple answer is that they should not. Once upon a time, there were some advantages to dividend plans but now they serve no purpose except to reduce the wealth and income of old retirees like this person who wrote to me. The regulator, Sebi, should force mutual funds to convert them to equivalent SWP plans.

    Now we come to the SIP issue. This retiree basically cycles money in and out of ELSS plans every three years in order to save tax. He invests in ELSS funds and after the three year lock-in, he withdraws the money and invests it again to gain the tax break. He feels that SIP is pointless for this and he is absolutely correct. SIP is needed when one moves money from a non-equity situation (like your bank account or a deposit) into an equity fund. This protects investors from catching a market high and losing money.

    If the money is already in an equity fund and you are just redeeming and reinvesting it, then SIP is not needed, this being one of those rare situations where that is true.
    ( Originally published on Oct 21, 2019 )
    (Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

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