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Home > Business > Special

Dividend payouts: What you need to know

Amit Trivedi in Mumbai | May 07, 2007

Investors tend to get confused with the jargon associated with mutual funds.

For instance, during an investor meet, someone asked me about the dividend policy of our company as far as equity funds are concerned. I explained that normally, we try and pay dividends once a calendar year.

But he was not interested in knowing the frequency - he was more interested in the quantum. I said, generally the yield is around 10 per cent to 15 per cent of the net asset value (NAV), if one looks at the history of the dividends paid out by us. His response was immediate: "It is too low. Most of the other fund houses are paying as high as 50 per cent or 60 per cent," he said.

That set me thinking. Were we talking two different languages or comparing apples and oranges? The answer is 'No'. Then I went on to explain to the gentleman that while the percentage yield that I mentioned was related to the prevailing NAV of the units, the yields that he was referring to were with respect to the face value of the units. And since the prevailing NAV is higher than the face value of units, the yield is just sounding lower. 

For an investor, actually neither approach can make much sense as the the price at which he had bought the units could most often be completely likely to be different from either the face value or the NAV or both. However, for the purpose of standardisation, one may look at either of the ways mentioned above - dividend as a percentage of face value or prevailing NAV. Between the two, yield as a percentage of prevailing NAV will give more conservative results, since the NAV would be higher than the face value.

For example, the current NAV of fund X is say, Rs 25 (face value is Rs 10). Now the fund declares a dividend of Rs 5. So, the dividend yield is 50 per cent, if we consider the face value. But it would be 20 per cent, if one looks at the prevailing NAV.

Now, since investors enter the fund at different times and different NAVs, the fund management company publishes the dividend as 50 per cent on face value, for the sake of simplicity or uniformity. This is because, if the investor bought the units only at the time of the dividend, so the yield would be 20 per cent. Similarly, if the investor has entered the fund at  the NAV of Rs 20, the yield would be 25 per cent.

This brings us to another point regarding dividends. Many investors invest in funds in order to get the dividend that is due in the next few days. Of course, the Securities Exchange Board of India (SEBI) has tried to curtail this kind of short-term investment by asking the funds not to declare their date of dividend before 5 days However, even from a personal finance point of view, one should remember that when a fund pays out dividends to investors, the same is paid out of the reserves. This means the NAV would fall to the same extent of the dividend paid out. Moreover, there is some entry load to buy the units.

Most investors feel happy that they are tax-free dividends. In reality, they are getting part of their own money back tax-free and they happily pay entry load for that. However, if the same investor has been holding units in a fund for five years and has been getting dividends every year, that makes much more sense.

One should remember that dividends come from the profits made through the operations. When companies make profits, part of the same gets distributed to the owners of the business in the form of dividends. This is considered a good risk-control measure since there is always undue speculation about the handling of surplus cash by the management. 

However, for an investor seeking growth of capital over longer periods, not taking dividends out would be an advisable option. In fact, even in case of stocks also, reinvesting the dividends back to buy the stocks makes more sense if the objective is to get growth of capital over longer periods.

Sometimes, investors argue that they depend on the dividend income to meet their expenses. For such a need, the investor should consider investing in predominantly debt-oriented funds and not equity-oriented funds. The basic idea of reinvestment of dividend allows an investor to take the benefit of compounding.

In short, while definitions in dividend payout may different, it is advisable to remember that the basics of returns stay the same. More importantly, it is advisable to opt for a growth plan when investing in an equity fund. And for dividends, opt for debt funds.

The writer works with a leading mutual fund house and the views expressed here are personal.

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