Why you should ditch dividend plans

Historically, many investors choose dividend plans over the growth option to get their regular income. But Dhirendra, you suggest that we should ideally avoid dividend plans. Why is that so?
Dhirendra: There is a history behind why people feel comfortable with dividends. When you get dividends from a company, it is an evidence that the company has been performing well. Dividends follow a lot of things. A dividend is basically a part of the residual money that is left with the company after meeting all expenses, financial obligations and keeping some money aside for growth. So it is like a certificate that the company is doing so well that it has met all its obligations, paid taxes, kept some money aside for growth and is even then left with some money.

But this thing is not extended to mutual funds. It never made sense because in case of mutual funds, whenever you get a dividend, the dividend amount is arithmetically subtracted from the NAV. So assuming that the NAV of your fund was Rs 20 yesterday and today it gives you a dividend of Rs 1, the NAV will immediately fall to Rs 19. So it is like taking your own money back. It is not an additional income like we have when a dividend is given by a company.

What is the harm in opting for a dividend plan, even if it means periodically withdrawing your own money?
Dhirendra: It was not a problem till January 2018 because there was no tax implication on that. Until then, dividends from equity funds were completely tax free. But now they are liable to a Dividend Distribution Tax (DDT) of 10 per cent. So if the company gives you a dividend of one rupee, you get only 90 paise after the deduction of tax.

Also, investment in equity funds is meant for the long term. You don't invest in equity to derive regular periodic income. By getting a regular dividend from an equity fund, you are basically taking out the good money out of what shall be left to grow. Equity funds are for long-term investment and should not be used for such short periodic cash flows. And as I said earlier, dividend is not a certificate of performance for an equity fund.

So your advice pertains to equity funds. Will your advice change when it comes to non-equity funds?
Dhirendra: The Dividend Distribution Tax (DDT) is even higher in case of non-equity funds. You pay around 29 per cent of the dividend amount in taxes. On the other hand, if you withdraw within three years, only the capital gains are added to your income. And if it happens to be after three years, you are liable to just 20% of tax on the gains, that too after providing for the benefit of indexation. Indexation is like adjusting your cost of purchase to inflation. So I would say, getting returns in the form of capital gains is a more tax-efficient way than dividends.

What about investors who are already invested in dividend plans? What should they do?
Dhirendra: Move your money to the growth plan and make it happen in a planned way so that you are not liable to an exit load or short-term capital gains tax. Just be conscious of the tax implications and the exit load and move your money out of it. That is it.

Click here to register for the forthcoming episode of Investors' Hangout and post your question for Dhirendra Kumar.