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Dividends in Index Funds

I have invested in a Nifty index fund. From time to time I read that many of the Nifty stocks declare dividends. But I haven't got any dividends. Where do these dividends go?

I have invested in a Nifty index fund. From time to time I read that many of the stocks here declare dividends. But I haven't got any dividends. Where do these dividends go?
Ruby Mathur, via e-mail

You are correct in that most of the stocks in the Nifty or the Sensex do declare dividends. Recently, Hero Honda, an index-constituent, declared a large dividend, resulting in a yield of 8.85 per cent as on May 1, 2003. However, , the dividend declared by the index as a whole is not much. The dividend yield on the Nifty, as on March 31, 2003, is 2.93 per cent. Compare this with Birla Dividend Yield Plus—which focuses on dividend yielding stocks—it has a dividend yield of 6.35 per cent.

The dividend declared by stocks that the fund holds go back into the fund. This is reflected in the NAV. But because the quantum of dividends is very low, the dividend declaration does not result in a significant appreciation. One way to measure the effect of these dividends is to take a look at the Total Returns Index. The Total Returns Index of any index is an index whose value reflects the dividends that are re-invested into the index. Because of this re-investment the value of the Total Returns Index is always greater than that of the underlying index. In fact, an accurate way to measure how well your fund is performing is to see if it is replicating the returns of the Total Returns Index.

As to when will you get the dividend, it is dependent on the fund you have invested in and the option you have chosen. Many index funds do not have a dividend option. This means that any gains you wish to take will have to be obtained by redeeming units from the fund. If you are invested in the dividend option of an index fund, you can wait for the scheme to declare dividends or withdraw units. Getting a dividend from the fund will, however, be more tax-efficient. While booking gains will subject you to a short-term capital gains tax at a marginal rate, long-term capital gains will be taxed at 20 per cent with indexation, or 10 per cent without indexation, whichever is lower. Dividends, on the other hand, are completely tax-free for this financial year.

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