Recently mutual funds have started issuing bonus units instead of declaring dividends. Is it
worthwhile to invest in such a fund, which is about to declare a bonus issue? What would be the impact of the bonus issue on my investments?
There is a popular perception that in a bonus issue a mutual fund issues additional units to investors without asking them to pay for it. However, a bonus issue is just a way of distributing profits earned by the fund. If you enter a fund just with the aim of receiving the bonus you will not obtain any financial gain.
A bonus is just an accounting device—on the day a bonus is declared the NAV will fall in proportion to the bonus declaration. Suppose you invest Rs one lakh in a fund which has an NAV of Rs 20. So you have 5,000 units in your account in the beginning.
Assuming that the fund declares a bonus of 1:1 (one unit for every one unit you hold) you will receive 5,000 units more taking the total number of units you hold to 10,000. However, the NAV of units will also fall in the same proportion. So post bonus the NAV of units will be Rs 10. As a result the total value of your investments will be unchanged.
The point here is that dividends, bonuses and other such rewards are given out of accumulated profits. If you have not been with the fund long and your money has not generated sufficient return, you don't get the profits. A similar situation arises when one tries to enter a fund just to get dividends. Effectively, dividends come out of the capital invested giving no profits to the investor in such cases.
Funds give bonus units because the other ways of distributing profits—dividends—have become tax unfriendly. Dividends are taxed according to the income bracket of the recipient and at the highest slab. This is currently 31.5 per cent. Bonus units, on the other hand, if held for a year attract long-term capital gains of 10 per cent (without indexation) or 20 (with indexation), whichever is lower.
Dividends and bonuses apart, we believe that the best investment decisions are made when financial goals are kept in mind.