Dividends are a method through which mutual funds distribute a portion of their profits to investors. These profits can arise from two primary sources: the surplus returns generated by the fund manager’s investment decisions and the dividends received from the underlying securities held within the mutual fund. When the fund performs well and earns returns above its operational costs, it may choose to distribute a part of these earnings to its investors as dividends. Similarly, if the fund's portfolio includes shares of companies that declare dividends, these earnings are passed on to the mutual fund's investors. The frequency and amount of dividends depend on the fund's performance and the dividend policy established by the fund house. For investors, dividends provide a regular income stream, although they are subject to taxation as per the prevailing tax laws, and may not necessarily indicate the overall performance of the mutual fund.
Investing in mutual funds is becoming one of the most prolific investment strategies as people are increasingly preferring to invest in a diverse portfolio of stocks, securities and bonds. By investing in a diverse portfolio, the possibility of risk becomes narrower, though mutual funds are subject to market risk.
Mutual funds are also appreciated for paying dividends to its investors and there are clear guidelines about how mutual funds pay dividends. It is mandatory under regulatory requirements for Asset Management Companies to pay dividends to unitholders from time to time.
For example, when units are sold and the sale price (Net Asset Value) is more than the face value of the unit. A portion of the sale price can then be credited to an Equalisation Reserve Account and used to pay dividends.
With respect to when do mutual funds pay a dividend, the SEBI, a regulatory body for stocks and securities market in India, issued a circular in November 2022 to the effect that Asset Management Companies will have to pay dividends to unitholders within seven working days from the time it reports dividends.
What are mutual fund dividends?
When a mutual fund earns returns, the asset management company of the mutual fund distributes a portion of these returns, called dividends, among the shareholders of this fund. It has been made mandatory by the regulatory authorities for the asset management companies to share the mutual fund dividends with shareholders.
The asset management companies will pay dividends as per the categorisation of the mutual funds. In case of unlisted schemes, the asset management companies will pay dividends subject to the availability of distributable surplus while, in case of listed schemes, they will pay it subject to listing agreement for dividend declaration and distribution.
When do mutual funds pay dividends?
It is mandatory for asset management companies of mutual funds to pay dividends to the unitholders when it earns returns from time to time. To solve the question of when do mutual funds pay dividends, the rules mandate that it can be done on daily, monthly, or yearly basis, depending on the type of the mutual fund.
In case of liquid/debt schemes, mutual fund dividend distribution frequency can range from daily up to monthly basis. However, the unitholders should receive their dividends within seven working days of the declaration of the dividend. The time period was reduced from 15 days to the current seven days in November 2022.
In case the asset management company fails to pay dividends to the unitholders within the stipulated time frame, then interest for the period of delay would be payable to the unitholders at the rate of 15 per cent per annum, which would be borne by the company.
Do all mutual funds pay dividends?
No. All mutual funds do not pay dividends, even though they may all be generating profit. The reason for this is that mutual funds offer several options to investors about what is to be done with dividends. The choice is three-way: whether the investors want dividends back; do they want their dividends to be reinvested; or do you opt for the mutual fund to grow without seeking dividends. Also, there are funds which specifically pay high dividends and are suitable for long-term investments; these funds are called Dividend Yield Funds.
Here are the three dividend investment plans:
| Option/Plan | Details |
| Dividend Payout | Here investors seek dividends as due to them from time to time. |
| Dividend Reinvestment | Here investors authorise the reinvestment of their dividends to same scheme or other schemes |
| Growth | Here dividends are not announced, rather the fund is let grow |
Why do mutual funds pay dividends and interest?
Mutual funds pay dividends and interest to comply with tax regulations and distribute investment income to shareholders. By law, mutual funds must pass on nearly all the income they earn from their investments to avoid being taxed at the fund level. This income typically comes from dividends paid by stocks and interest from bonds held within the fund’s portfolio.
Instead of retaining this income, mutual funds distribute it to their shareholders, who are then responsible for reporting it on their own taxes. Similarly, if the fund realises profits from selling securities, known as capital gains, these are also distributed to shareholders.
The timing of these payments depends on the fund's policies, but most funds pay dividends or interest at least once annually. This ensures that shareholders receive their share of the fund's earnings while aligning with regulatory requirements to minimise the fund's tax liability.
What happens when the dividend is paid?
When a mutual fund pays a dividend, the declared amount is distributed to its shareholders. This payment typically occurs in cash and is credited directly to the investor's registered bank account or reinvested in additional units of the mutual fund, depending on the chosen option. Once the dividend is paid, the fund's Net Asset Value (NAV) decreases by an amount equal to the dividend per unit, reflecting the outflow of cash from the fund's assets.
For investors, receiving a dividend represents a share of the fund's profits, but it also has tax implications. Dividends are taxable as per the investor’s applicable tax slab or the prevailing tax regulations. Importantly, the dividend payment does not necessarily indicate a gain in the investment's overall value, as it is merely a distribution of profits already accounted for within the fund. Consequently, investors should consider dividends as part of their total return.
How do dividends affect a fund's NAV?
NAV means Net Asset Value. It is the market value of a single unit of a mutual fund and is used as a reference pointer for the growth, purchase or liquidity of the investment. When the dividend is received by an investor, the key takeaway to remember is that the value of the mutual funds, its NAV, falls.
How are dividends paid?
The investor receives the amount that is worth to him as the dividend, in cash or cheque or is delivered digitally. In addition, if there is a delay on part of the asset management company to pay the dividend within the stipulated time frame, then the investor is also eligible for an interest amount for the time period of delay.
Should you have dividends reinvested or paid out?
Choosing between reinvesting dividends or receiving them as payouts depends on your financial goals and investment strategy. Reinvesting dividends allows you to purchase additional units of the mutual fund, compounding your investment over time. This approach suits long-term investors focused on wealth accumulation, as it enables growth by leveraging the power of compounding.
On the other hand, opting for dividend payouts provides regular income, which can be beneficial for individuals seeking cash flow, such as retirees or those with immediate financial needs. However, receiving dividends as payouts may reduce the potential for capital growth since the funds are not reinvested.
Additionally, tax implications play a role. Reinvested dividends are treated as new investments and may be subject to capital gains tax when sold, while payouts are taxed as income. Ultimately, the decision should align with your financial goals, risk appetite, and investment horizon, considering both the advantages and potential drawbacks.
Key takeaways
- Ideal for long-term investors, as it compounds returns over time.
- Suitable for those seeking regular income, like retirees or those with immediate needs.
- Reinvesting generally leads to higher potential growth compared to receiving payouts.
- Both options are taxable, but reinvested dividends are treated as capital gains when sold.
- Choose based on your financial goals—reinvestment for growth or payouts for income.
Conclusion
Mutual funds are an attractive investment instrument and valuable product for those who are looking for a diverse portfolio and minimal risks. By spreading investments across a diverse array of stocks, bonds, securities, and market segments, mutual funds can be aligned with individual risk-reward profiles. The transparent, affordable, and liquid nature of mutual funds makes them a favoured choice for retail investors.
