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 dividends from equity funds, 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 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, dividends from equity funds 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. Tweet Now
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. Tweet Now
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.
The Dividend Stars smallcase invests in companies that have maintained an average dividend yield of at least 3% over the previous 10-year period without any cuts in dividends during that period
The Dividend Aristocrats smallcase invests in companies that have increased their dividend payout consecutively for the last 10 years.
The Dividend – Smart Beta smallcase invests in large-cap companies increasing their dividends on a consistent basis
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