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Why the dividend option of mutual fund schemes is no longer attractive?

For long dividends has been a big draw for investors and a key selling point for mutual funds. But, now dividends are on their way out. Recently, Motilal Oswal AMC launched a hybrid fund offering that has done away entirely with the dividend option. Instead, the fund company is promoting the systematic withdrawal plan (SWP) for those seeking a regular cash flow.

Until recently, several fund houses were known to aggressively sell the dividend option of mutual funds as a source of regular income for those investors looking to capture more assets under management, particularly in equity-oriented funds. Previously, dividends were entirely tax free in the hands of the investor. They were promoted as a tax efficient and safe avenue for investors to generate steady income. Some schemes were even promising 1 per cent assured monthly dividend payouts on the principal invested.

This caught investors’ fancy and the corpus managed by balanced or hybrid schemes swelled sharply in a short span of time. However, the incentive was taken away with the government introducing a 10% tax on dividends from all equity funds. Tax burden along with the dwindling dividends in some of the schemes has led many investors to move away from the dividend option.

Irrespective of the tax consideration, the dividend option is not a healthy avenue. Dividends are paid out of the profits and distributable surplus accumulated by the fund over the years. The dividends are at the discretion of the fund house and may become erratic depending on the fund’s performance. Also, since the dividend is paid out of the profits, it reduces the NAV of the fund to that extent. Essentially, it is the investor’s own money being returned. The money so taken out also impedes the compounding effect over the long run. Besides, experts argue that investors should not enter an equity-oriented investment for the sole purpose of income generation.

The alternative being promoted by Motilal Oswal AMC, the Cash Flow Plan, is actually an SWP option by another name. It will allow investors to withdraw a regular sum from their investments at a fixed percentage of the original investment amount. Withdrawals will be in a predefined frequency irrespective of the movement in market value of the investments. This way investors are guaranteed a steady income and can customise the income flow as per their needs.

A small investor may be able to avoid tax incidence altogether if the long-term capital gain accrued on the amount withdrawn through SWP is less than the Rs 1 lakh exemption threshold. With funds also starting to wean investors away from the dividend play, investors would do well to reconsider their own investing approach.

 

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