Want money at periodic intervals? Go for dividend plans of equity MFs

Go for dividend plans of equity MFs for steady cash flow

Investors should consider dividend plans of equity mutual funds if they need money at periodic intervals.

For a steady cash flow
Illustration: Raj Verma

Nilesh Rokadia, a mutual fund distributor in Raigad district, near Mumbai, has several clients who need regular income, including some who are retired. Rokadia often prefers to recommend them to invest part of their portfolio in dividend plans of equity funds instead of monthly income plans (MIP) of debt products for regular cash flow. "Inadequate exposure to equities could lead to a shrinking of their investment portfolio since debt investments will normally give returns that are lower than inflation," he says.

This is because equity as an asset class has the potential to outperform other asset classes over the long term. Moreover, the dividend paid out by debt funds is subject to dividend distribution tax at 28.325 per cent in case of individual and Hindu Undivided Family investors and 33.99 per cent in case of local companies whereas dividend paid by equity funds is tax- free. So, investors get higher dividend in case of equity funds.

Let us explain this with an example. An investor who put in Rs 10 lakh in ICICI Prudential Value Discovery on January 1, 2008, would have received a total of Rs 2,96,436 as dividend and the current value of that investment would have been Rs 25,20,474, growing at a compound annual pace of 14.63 per cent (excluding dividend). Had the investment been made in Reliance MIP, the dividend would have been Rs 8,40,654 and the current value of the investment would have been Rs 20,12,047, giving CAGR returns of 10.88 per cent (excluding dividend). While there will be no tax on the dividend received on ICICI Prudential fund, the investor would have to pay tax on the Reliance MIP scheme at the rate of 33.99 per cent.

Of course, not all dividend equity funds pay every year. ICICI Prudential Value Discovery is one of the few funds that has given out regular dividends, even in a year when it reported negative returns, while Mirae India Opportunities is among those that pay dividend only if it had achieved positive returns in the previous year.

Feroze Azeez, Director - Investment Products, Anand Rathi Private Wealth Management, says retired people should ideally meet their liquidity needs for three years by the debt portion of their portfolio. If investors need regular income from their equity investments to support their living expenses, they can opt for the dividend option in equity funds, especially if the requirement is in the first year of their investments. "The decision to invest in funds with a dividend payment track record depends on the investor's liquidity requirements and time horizon," he says. "If you need liquidity one year after making the investment, you can choose the growth option and benefit from the compounding effect and later consider the switch-out option at regular intervals as equity MFs are not taxed after a year," he adds.

But not everyone is in favour of dividend-paying equity funds. Mumbai-based investment advisor Rohit Shah says he does not recommend this option to his clients. "The growth option is better as it helps increase overall returns. But investors should choose the growth option only if they do not need immediate returns," he says. "We suggest that investors don't depend heavily on dividend income since these can fluctuate. The advantage of dividend-paying equity funds is that the profit gets booked regularly," he adds.

Choosing Dividend-paying
MFs: A Checklist
  •  Consistency of dividend payout
  •  Record across market cycles
  •  Prevailing market situation and future prospects
  •  Asset allocation, liquidity status
  •  Prevailing fixed-income returns
  •  Tax rate and income level
Sankaran Naren, CIO, ICICI Prudential AMC, opines: "While dividend history is a good indicator of a fund's performance, investors also need to consider other parameters like fund strategy and suitability." An important point to note is that dividends are paid out of NAV. So, the NAV drops to the extent of the dividend paid. Naren says debt as an asset class is less volatile as compared to equities. So, dividend-giving debt funds are more predictable compared with equity funds in terms of regular income. "People who need cash flow cannot depend on the unpredictability of when and how much dividend will be declared. In that case, MIPs or hybrid products could be more suitable," he says.

Should You Invest?

Not all funds consistently give dividends. Even if an equity mutual fund pays dividend annually, the time and rate of dividend are not fixed, although patterns can be spotted for a few funds. For example, Franklin India Bluechip fund has a good track record of giving dividends and it usually pays it in January. Also, the rate depends on the profit earned by the scheme. "If you need inflows at frequent intervals you may have to opt for a debt mutual fund that has a monthly, quarterly, half-yearly as well as annual dividend option," says Azeez of Anand Rathi.

Shah says that, since the returns on equity MFs are market-linked, poor performance can negatively impact cash flows. "If one has surplus funds, it may be better to invest in growth-oriented diversified equity MFs for at least five years. This can help generate a decent corpus and can be of good use in later years of retirement stage," he suggests.

Rokadia, the Raigad distributor, says he suggests a mix of MIPs and dividend-giving equity fund to investors who need regular cash and have less money. To investors who have an investment portfolio of more than Rs 50 lakh and a high risk appetite, he suggests investing part of the amount in dividend-giving equity funds.

Naren says an investor who is retired or nearing retirement should preferably be inclined towards funds that offer stability of returns. So, MIPs or hybrid schemes should make up a larger portion of their investments while some portion could be allocated to equity for long-term growth.