The 2018 Union Budget had turned out to be a disappointment for equity mutual fund investors who had invested in dividend plans. The Finance Minister introduced a 10% dividend distribution tax (DDT) on mutual fund dividends, which were earlier entirely tax-free. This tax might put a dent in your dividend income from equity funds, but it is also the right opportunity to understand that mutual fund dividends are not actually dividends.
What is a dividend?
The term ‘dividend’ comes from the Latin word ‘dividendum’ that means ‘thing to be divided’. Hence, a share dividend is the division or distribution of a company’s profits to the company’s shareholders.
When a company earns a profit, it can choose to either employ the profit to further expand its operations or it can distribute this profit among its shareholders in the form of dividends. Generally, a company will pay out a part of its profits to its shareholders and use the rest of the profit to fund business expansion plans.
The dividend you receive would be related to the number of shares you hold. For example, if company A announces a dividend of Rs 10 per share and you hold 5 shares of the company, you will be entitled to Rs 50 worth of dividend income.
Equity fund dividends versus company dividends
On the other hand, mutual fund dividends are not actually dividends. A dividend from a company is additional income that you receive over and above the capital gains made by holding the shares. In case of equity funds, the dividend is paid out from the gains you have made by holding the units. Hence, equity fund dividends are not an additional income, but a part of the gains you have already earned.Equity fund dividends are not an additional income, but a part of the gains you have already earned. Click To Tweet
When you get a dividend from an equity fund, the value of your units goes down.
Let’s say you hold 100 units of an equity fund that is currently worth Rs 1,000. Now, since you have invested in the dividend plan, the equity fund pays you a dividend of Rs 100. In this case, the value of your units would come down to Rs 900. This is how equity fund dividends eat into your own corpus and minimise the magical effect of compounding interest.
Hence, to actually earn a dividend income, you should invest directly in the stocks of dividend-paying companies. Dividend income is important because it helps you earn over and above the capital appreciation you see in the shares you hold. Dividends also become an added incentive to hold onto the shares because most companies typically pay out a dividend once or twice a year.
Companies with high dividend yields also see an appreciation in their share prices because such companies are expected to continue doing well and attract investors. Dividend-paying stocks should ideally be held for the long-term so that you benefit from dividend income as well as the company’s growth.Invest in high dividend yield companies for the long-term to benefit from dividend income as well as capital appreciation. Click To Tweet
Investing in high dividend yield companies
Of course, it is not easy to pick high dividend yield companies. You can’t invest merely on the basis of high dividend yields; you need to ensure the company meets other important investment criteria as well. The solution to this problem is investing in one of our dividend smallcases.
A smallcase is a basket of stocks or ETFs that relate to an idea, theme or strategy. Similar to mutual funds which help you build a diversified long-term portfolio, smallcases offer the additional benefits of being simpler to understand, low-cost and transparent.
Created by SEBI-licensed professionals, smallcases are trusted by over 2,00,000 investors.
- The Dividend Aristocrats smallcase invests in companies that have increased their dividend payout consecutively for the last 10 years.
- The Dividend Stars smallcase invests in high dividend yield companies with a track record of not cutting dividends.
Why smart investors choose smallcases
smallcases make it easy for you to invest in the equity markets. A smallcase is a basket of stocks or ETFs that relate to an idea, theme or strategy. Investors can choose from 50+ readymade portfolios created by professionals and invest in just 2 clicks through our broker partners – Zerodha, HDFC securities, Axis Direct, Edelweiss and 5paisa.
Here are some recommended articles to help you start investing in smallcases.
- First-time investor? Here’s how to get started with smallcases
- 10 reasons why smallcases are Behtar than mutual funds
- Why direct stock investors should invest in smallcases
Stock investing made easy
Stop picking stocks you don’t understand, start investing in ideas through smallcases
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