Must mutual funds declare dividends?

I have invested in mutual funds, but have opted for the dividend based schemes. Unfortunately, I have not received any dividend till date.

Their Net Asset Value keeps increasing, so why are the funds not declaring dividends.

My questions are as follows:

1. How often do funds declare dividend?

2. Is there any upper limit for tax exemption on dividends?

- Dhiraj Kumar

Risk profile

Your risk profile does not matter when you select a growth or dividend scheme.

For instance, a person who is not willing to take a high risk may invest in a balanced fund where part of the total amount is invested in fixed-return investments and part in shares.

But a person who is willing to take a higher risk may invest in a diversified equity fund.

Within these funds, an investor may opt for a growth or dividend scheme; this choice is not dependent on his risk profile.

You described yourself as a high-risk, high-return investor, so we assume you have invested in diversified equity funds.

Growth and dividend

A mutual fund generally offers two schemes: dividend and growth.

The dividend option does not re-invest the profits made by the fund through its investments. Instead, the profits are shared with the investor from time to time.

In the growth scheme, all profits made by the fund are ploughed back into the scheme. This causes the NAV to rise over time.

That is why the NAV of the growth option will always be higher than that of the dividend option because money is going back into the scheme and not given to investors. 

In a mutual fund, it does not matter how many dividends get declared as it is just a part of your returns being given to you. It is not something extra that you get, like in shares.

Can the fund pay a dividend?

First of all, a fund must be in a position to pay a dividend. Funds pay out dividends from the gains they have made. A simple way to find out is to check its NAV, which is the price of a unit of a fund.

An NAV above Rs 10 shows that a fund is in a position to pay dividends.

You say that the NAVs are increasing, so your funds should be in a position to pay dividends.

However, a fund distributes dividends at its discretion.

There is no guarantee or assurance that a fund will pay dividend even if it has the money to do so.

Mutual funds are not obliged to declare a dividend. Investors must understand that a dividend is not guaranteed.

If a fund declared dividends twice last year, it does not mean it will do so again this year. You could get a dividend just once this year and you might not even get it next year.

Funds issue dividends subject to the availability of the profits they can distribute and it also rests upon the discretion of the fund manager.

It is solely upto the fund as to when to declare a dividend and how often to declare it.

It is just a myth that a fund is supposed to declare a dividend every month. There is no legal compulsion upon any mutual fund to declare dividend on a regular basis.

Some funds differ

Some funds may declare more frequent dividends than the rest.

That does not make them inherently better.

For instance, the Birla Dividend Yield Plus fund has declared 11 dividends since its launch in February 2003. An excellent dividend track record for just two-and-a-half years. 

However, the objective of the fund manager is to invest in the shares of companies that offer high and regular dividend.

• A fund with frequent dividends

Why you should not be too concerned

Dividends are not 'extra' gains that you get.

For example, say there is a fund with an NAV of Rs 18. When it pays a dividend of 20%, its NAV will drop to Rs 16, since it has paid out Rs 2 (20% of the face value of each unit of Rs 10 is Rs 2).

If it does not pay the dividend, the NAV will stay at Rs 18 so you will make a profit when you sell the units.

The important point is that you should not worry about dividends in equity funds. The purpose of investing in an equity fund is to make your money grow. You should be more concerned about the growth of your fund's NAV.

Tax

There is no upper limit for tax-exempted dividend.

As per the existing tax laws, whatever dividend is declared by a mutual fund is tax-free in the hands of the investor.