In this episode of Breaking Myths, CNBC-TV18's Surabhi Upadhyay is here to bust another very common myth specifically one that applies to a lot of mutual fund investors regarding dividends.
The myth is that dividends from mutual funds are like additional income from the fund. However, this is absolutely inaccurate, it is absolutely untrue and this is not how dividends work.
When you are investing directly in shares and then you are receiving dividends from the company that is additional income, as there is a return that you are making over and above the return from the share price appreciation. But this is not how it applies or how it works on mutual funds.
Mutual funds invest in the basket of stocks and whatever dividends they are receiving from those stocks that anyway is a reflected in the net asset value (NAV) that determines how much you are making in that fund.
Now, when you go for the dividend option, the fund takes out a bit of the money from its total corpus and gives it to the mutual fund holder or investor.
What it is actually doing is diminishing your future returns as that money is going out to you. It will no longer compound, the power of compounding will not apply to that part of the corpus because it has been paid out. So, actually your effective return at the end of your holding period will be lower a the compounding power has not really worked as beautifully.
The other aspect is taxation. Dividends are taxable. But when it comes to dividends from equity funds, the tax is at 10 percent. When it comes to dividends that are paid out by debt funds, the tax is at 25 percent. So, it is not a very efficient way of retrieving money from that investment that you have made in a mutual fund.
That is why experts say don’t go for the dividend option, please go for the re-investment option. Also, investors can opt for the Systematic Withdrawal Plan to take care of the monthly income requirement.