How to Earn Dividend in Mutual Fund Schemes

Many a time, investors like the idea of intermittent cash flow from their investments, as it gives them a cushion to manage expenses. Such investors tend to opt for the 'dividend option' in mutual funds. 

1. What does dividend option mean in a mutual fund? 

Any mutual fund scheme can declare dividends for its unit holders from the realized profits in its portfolio. Realized profits are the gains made by the scheme from instruments by selling them at a price higher than what they were purchased for, or when the securities held in the scheme receive dividend or interest (in the case of debt funds) from the instruments held. Unrealized profits from the instruments held cannot be used to pay dividends. These profits are added to the NAV. Some part of this can be declared as dividend, depending on the fund manager. Alternatively, the fund manager also has the option of deploying the money back to buy stocks or debt instruments in line with the scheme's objectives.

2. When can you expect dividends in a mutual fund scheme? 

Mutual funds can pay dividend on a daily, monthly, quarterly or annual basis, as it varies from one scheme to another. There is no guarantee of dividend payment, but most of them endeavor to pay dividend and stick to their respective mandate. However, the dividends are not certain and the amount is also not fixed. Under dividend option, the NAV is not let to grow higher, and whenever it reaches a certain level, the fund house pays out dividends. Let's assume you have invested in a fund at an NAV of Rs 14 and chosen the dividend option. The scheme performs well and after appreciation the NAV reaches Rs 16. The fund house may decide to pay out Rs 2 as dividend. So you receive Rs 2 and simultaneously the NAV will fall back to Rs 14. 

3. Do you have to pay tax on dividends in mutual funds? 

Dividends received from all mutual funds are tax-free in the hands of the investors. However, in the case of debt funds, the fund house pays a dividend distribution tax (DDT) of 28.84 per cent, which includes surcharge and cess. In an equity mutual fund, there is no dividend distribution tax. 

4. Should you opt for the dividend option? Will it work for you? 

Financial planners recommend dividend option in equity funds for investors who are risk-averse and for those looking for some cash flow. For those looking to build wealth over the long term, it is advisable to go for the growth option. This is because the compounding benefit is lost when dividend is paid. Those in the highest tax bracket and investing for less than three years could opt for daily dividend option in liquid/ultra-short term funds as the DDT is lower compared with the tax slab of 30.9 per cent.