Understanding dividends

Personal finance
1

Hi!

I’m very new to the investment world, so I’m apologising in the beginning if the question is too obvious. Also I’m sorry if it’s asked before, but i failed to find relevant threads.

I recently started to invest in mutual funds, and came across the terms of Growth and Dividend. Based on initial not-so-deep google searches, I visualised these as similar to simple and compound interest, the same options we get while creating fixed deposit in banks. However, I received account statements for first time today, and came across the terms “Dividend Payout” and “Dividend Reinvestment”. Now it contrasts with my assumed notions, as I can not visualise difference between Growth and Reinvestment.

I want to understand the difference, and hence let me set up a context.

  1. Suppose I buy 500 units from a mutual fund at ₹20/- NAV in beginning of a financial year i.e. I invested total ₹10,000/-.
  2. Consider the scenario that at the end of the financial year, NAV stands at ₹25/-, resulting total worth of my shares at ₹12,500/-.

I assumed the following for the two options:

  1. In Growth, there will be no effect whatsoever and the same 500 units will continue to next financial year, where their worth may increase, decrease or remain as it is. There will be no tax applicable, until I choose to sell some units that I own at which point it’ll be considered as capital gain.
  2. In Dividend, ₹2,500/- will be paid out to my bank account. So, my total number of units after that will become 400, but investment worth will remain same as ₹10,000/-, as it was in the beginning. And I have to pay tax on the dividend of ₹2,500/- in the rate of my tax slab based on my salary.

After getting to know about types of dividend - Payout and Reinvestment, it seems that Payout will be somewhat similar to what I described above in point 2. Reinvestment, on the other hand, may be that I’ll get 100 more units, but will get nothing as cash. I’m not sure at all whether that’s the case or not, and no idea how “tax” will be calculated on that ₹2,500/-.

Please let me know whether my ideas are correct or not. I know for sure that it’s wrong for Reinvestment, so please help me correcting my understanding. If there are some other options/conditions which I don’t know about, I’ll be grateful if you can point those out as well and how they will impact this hypothetical scenario.

P.S. My question is mainly for the understanding of different options as of now. Obviously I’m interested to know what should work best for me, but first I want to understand what each options are, their pros and cons and etc.

(Note: I don’t use Coin, at least not yet. Hopefully that doesn’t matter.)

1 Like
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Hi

Welcome to this forum. I fairly know the answer to your query, but I will leave it to the experts to answer as half baked knowledge is more harmful. The reason for responding is for the following

You dont have to be apologetic in asking your queries in this forum. Out of the few forums I have been to and exited as most try to give a cocky answers, smart alec type of reply, I do not see such replies from the experts here. The max they go is “schooling” you to read. This is my experience.

Remember, it is queries like yours which makes this forum interesting. So keep posting and hope to read the experts reply to your specific query.

2 Likes
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Thank you very much for the warm welcome! :blush:

And thanks for this note as well. I moderate some discourse sites (programming related), where there’s quite a strict rules similar to Stack Overflow. So, I assumed the same.

4

Before anything else: never ever buy dividend versions of mutual funds. They make no sense, and will cause you to lose money as taxes if you fall in a non-zero tax slab. Always buy direct, growth versions of mutual funds. You can ensure this by checking that both the words “direct” and “growth” are present in the name of the mutual fund.

  • For growth funds, things are exactly as you described.
  • For dividend funds: it is not mandatory that any increase in the NAV is paid out. Paying out a dividend (this is now called some other longer name, not “dividend”, to avoid confusion with dividends from stocks) is at the discretion of the fund house, and many (most?) funds don’t pay out dividends at any regular intervals. They do it when they feel like it, as far as I understand.
  • For a dividend payout variant, the dividend that is declared is paid to your bank account, after deducting some TDS (if applicable; I think this depends on your tax slab, residence status, and other factors).
  • For a dividend reinvest variant, the dividend that is declared, minus TDS if applicable, is used to buy more units of the same fund.

In any case: just forget that dividend variants exist, never put your money into those.

Note that dividends (either paid out, or reinvested; it doesn’t matter) from MFs are now taxable in your hands at slab rate. This applies even in the reinvest case. Just don’t buy dividend variants. That is the most sensible thing to do.

3 Likes
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Thanks for the detailed answer @ZeroIndian, much appreciated.

But as you have probably figured out, I already bought dividend funds. Apparently, one (of debt type) has quarterly period, and another (equity type) is as and when applicable, like you said.

So, a follow up question is will it be possible for me to switch? If so, can it be done through the investment platform (I’m using Paytm Money, if it matters), or I’ve to contact the AMC directly? Or, switch is not possible, and I’ll have to sell these units and buy from the growth version?

I don’t know how is it different in stocks from mutual funds, because I haven’t started doing stocks myself yet. Just out of curiosity, can you please expand on this a bit?

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Even for this one, I think (I am not sure; check the scheme documents for your funds to verify this) that the “quarterly period” is just an indication, not an absolute obligation on the fund house. You could check the dividend history of your fund(s) to see if they really have declared dividends every quarter. You may find that they have missed doing this in some quarters when the NAV didn’t go up enough.

Depends on the fund. The switch facility is something that the fund house provides as a convenience. As far as I know, this is not something that they are obligated to provide for each fund. So you will have to check the scheme documents/brochure and see.

If the fund house allows a switch, then the platform normally allows it as well. I don’t have experience with Paytm Money, so I don’t know if Paytm allows switching. Again, this is at the discretion of Paytm, so they may or may not allow it for specific funds, even if the fund house provides the facility.

Consider the exit loads and tax implications before you do this. Some funds also have lock-in periods. If your funds have this, then you will have to wait till that period is over, before you can sell units.

Expand on what? If you have questions about dividends from stocks that a Google search did not answer, please ask and I will try to explain.

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Just to clarify, hope it is correct.
A mutual fund is basically collection of stocks. This basket of stocks is termed a specific mutual fund which is managed by a AMC. Here we have two aspects.

  1. The basket of stocks/companies which this fund holds will declare dividends (not necessarily but as and when they declare) and this dividend amount is paid by the company to the to the AMC as the AMC holds these shares under the MF. This cash is primarily used by the AMC to meet their expenses (as per prospectus) and the remaining will be retained in cash under the AMC or reinvested. The effect of this is your mutual fund NAV will increase. You as a individual unit holder of the MF will not get anything in return but your NAV will proportionately increase

  2. The other aspect is the AMC who owns the mutual fund will declare dividends to the unit holders i.e you as and when they feel it is appropriate. So when a AMC declare a dividend on a MF, you as a unit holder will get the dividend amount in cash to your bank account. The number of units you own remain unchanged, but what changes is the value of NAV will reduce by the dividend amount.

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Though you have not asked, i would like to give you some suggession. Though these Mutual Funds App are easy way to invest & gives you consolidated picture, they don’t have a facility to make a nomination for the investment you made thru them. and you have to take AMC rought for the same. In today’s senario of pandemic…nomination is must for your every investment; to save from hassles of your loved ones.

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This may or may not be true for all apps.
Not sure about others, but I use PayTM money and have nomination updated in all my folios automatically without any need of approaching individual AMC.
Maybe you can check again, most likely app you are using will also have facility of nomination.

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Thanks for the info, @neha1101 .

Especially for this part. I was thinking that by getting money in bank, my owned units will decrease to keep the NAV in check (i.e. point 2 in my example). Thanks for clearing that up.

Thanks for this unprompted suggestion @ShreyaDR , much appreciated. But as @Akash_Shah said, I see presence of nominee in my statements. That matches with the nominee details of my linked bank account, so I thought probably it’s fetched from it somehow.