For regular income - equity funds or balanced funds sahi nahi hai ...

Are you seeking regular income from your mutual funds? In that case, please do not look at equity funds or balanced funds. Do not consider regular dividends or even systematic withdrawal from such funds.

Read my article to know more ...

For regular income, equity and balanced funds sahi nahin hai ...

Read the English translation below:

Recent budget proposed by the Finance Minister introduced a tax on dividends from equity-oriented mutual funds. Some mutual fund investors and distributors were upset with this proposal. Some of them had opted for balanced fund seeking monthly dividend. Now these dividends have become taxable. The tax would impact the net amount received in hands.

First of all, let us understand the tax on dividends. This is not the regular income tax that is payable on the income received in hand. However, this is dividend distribution tax, which would be deducted before the dividend is paid out. The dividend that one receives remains tax-free in the hands of the recipient. This means that although the recipient does not have to add the dividend income in the taxable income and calculate the tax on it, it is received AFTER deduction of tax, which would mean that the investor’s returns are reduced.

This is what has upset those who invested in the balanced mutual funds seeking regular income.

We will not discuss about the merit of introducing such a tax. However, the focus of our discussion would be on the choice of equity or balanced funds to seek regular income. Before we launch the discussion, let us also add that now that the dividend is subject to distribution tax, many have started considering regular withdrawal, known as SWP (Systematic Withdrawal Plans) to get regular income. On paper, such a regular withdrawal strategy looks highly tax-efficient in comparison to dividends. This happens since the entire dividend amount is subject to tax, but in the withdrawal case, only the capital gains are taxable and not the capital withdrawn.

The question to consider should be: is it prudent to invest in equity funds or balanced funds for regular income? Very often, people get carried away with the taxes and try to save taxes, forgetting the true nature of the investment category. In the offer document of equity and balanced funds, an important item is called the “investment objective of the scheme”. In all such cases, the investment objective is “to provide long term capital appreciation” and not “to provide regular income”. In fact, even the nature of the asset does not support the ability to pay regular income.

We do not look at liquid funds when the objective is to create wealth. However, liquid funds are ideal when “liquidity” is the prime objective. Exactly in the same manner, if “long term growth” is the objective, equity could be a suitable asset category, but it is not suitable for short periods of time, or for liquidity, or for regular income.

- Amit Trivedi

 

A simple lesson from Warren Buffett for the mutual fund investors

Warren Buffett, arguably the greatest investor the world has ever seen,  wants the companies he invests in to pay him regular dividends, his company, Berkshire Hathaway, does not pay dividends to the shareholders. Can one blame him of employing double standards?

There is an interesting lesson for mutual fund investors here ...

Click here to read further ...

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The English translation is as under:

A simple lesson from Warren Buffett for the mutual fund investors

Warren Buffett is arguably the greatest investor the world has ever seen. Many have studied his investment philosophy and investment strategies in depth. There are many interesting facts about him.

One of the important aspects of his investing philosophy is that he insists that the companies he has invested in should pay dividend to the shareholders whenever possible. The last two words “whenever possible” do not mean “whenever the management thinks right”, the words mean  “whenever the company has surplus available for dividends”. While he wants the companies he invests in to pay him regular dividends, his company, Berkshire Hathaway, does not pay dividends to the shareholders.

Can one blame him of employing double standards? Well, in order to answer this question, we must understand his way of thinking.

According to Warren Buffett, he is one of the best “capital allocators” in the world. He understands how to allocate capital in a manner that the risk of loss is least, whereas there could be reasonable upside, too. That makes him the best investor that he is. Not many are blessed with such capabilities and few know what they are best at.

When he invests in companies, he wants the management to return the excess capital to the shareholders. He knows and strongly believes that between him and the company management, he can invest the money better.

Now let us look at the other side – the investors who have bought shares in Mr. Buffett’s company, Berkshire Hathaway. The firm is an investment company or a holding company that invests in other businesses and generates investment returns through better capital allocation. He does not pay dividends to the shareholders as he believes that the allocation of funds can be better done by him and his partner, Charlie Munger as compared to the shareholders. In fact, if the Berkshire shareholders were better investors, why did they invest their money in an investment company? They also know what Mr. Buffett believes – Mr. Buffett and Mr. Munget are far superior investors than these investors themselves.

So, what is the lesson for investors in mutual funds?

Please understand the difference between investing in a company’s business and giving money to a mutual fund manager to do that job. While in the first case, you are the investor, in the latter case, you are taking professional help for the same. That means, when a company makes profits and has no need for funds for deployment in the business, the management would pay dividend. However, if the fund manager pays dividend, what does the investor do with the same?

If you are anyway going to invest the money somewhere else, why not allow the fund manager to do it?

Think about it.

-       Amit Trivedi

So you haven't received the dividend from your mutual fund?

What happens to the mutual fund dividend that you have not received? Is it possible to get it back even aft6er years have passed? What care should you take to ensure you do not miss out on receiving these payments? Read my article in  Gujarati edition of today's Mid-day to get the answers to these questions.

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The English translation of the article is as under:

What if you did not get your mutual fund dividend?

“I invested in a mutual fund scheme that declared dividend some years ago. I did not get the dividend cheque. May be it was lost in transit. Will I lose that amount? Can I ever get it back?”

Well, as per the process, unclaimed dividends are deposited in an account with Investor Education and Protection Fund (IEPF). However, such transfer of funds happens only after such dividends remain unclaimed for seven years. The logic behind this was simple. If someone has not claimed the dividend for such a long period, there is a very high probability that the claim would never come.

One is not sure, but the logic used here could be in alignment with another law that states that any person missing for more than seven years is declared dead. This was required especially with respect to the distribution of that person’s wealth among the legal heirs.

The dividend rule also could have used the same time period for the purpose of depositing the unclaimed amounts in the IEPF.

However, there is an angle that is often missed out – human behavior. Some of the dividends may not be claimed for long periods purely due to lethargy. What if after a long gap someone realizes that one had not claimed the dividend?

In order to take care of such cases, the Government of India has changed a rule related to the unclaimed dividends. Even after this seven year period is over, one can claim the dividend back from the IEPF. In other terms, with one change in the regulation, the Government has taken a huge step in favour of the investor.

Having said that, it is also the investor’s responsibility to keep track of one’s own hard-earned money. Whether there is a facility to recover the money or not, being unaware of dividends for as long as seven years is not financial prudence.

So what should one do? First of all, one must review the investments on a regular basis – at least once a year. Second, please opt for electronic transfer of all the dividends into your bank accounts. In this way, you would be able to get rid of remembering whether you have received a cheque, deposited it in the bank, whether the cheque validity is over, etc. opting for electronic transfer of funds also removes various other risks related to paper movements, e.g. torn cheques, mutilated cheques, loss of cheque in transit, etc.

So, be careful with your money and take a few small but very important steps.

Dividend or growth - which option is better for a mutual fund investor?

My article in Mumbai edition of Mid-day Gujarati today (page 15, bottom half)

Click here to read ...

The English translation of the same is as under:

Mutual funds are supposed to simplify our lives. However, with more and more attempts at simplifying, the industry has increased the options and the choices for the investors. The number of choices now has reached intimidating proportions.

Let us demystify various dividend options. This should help us take better decisions and make the decision making process easier. We will discuss the objective behind the options and how these can be effectively used in order to achieve our goals.

In the parlance of mutual funds, dividend is distribution of income earned by the mutual fund portfolio. The fund’s money is invested in various securities – these securities generate returns in form of capital gains (difference between sale price and purchase price), interest (debt or money market securities), or dividend (in case of equity securities or other mutual fund schemes). Such returns, if retained in the mutual fund will result into increase in the NAV per unit. Part of these returns can be distributed to the fund’s investors. This distribution is called dividend.

Broadly, an investor can opt for either a dividend or a growth option. Then, within the dividend option, there are choices like the periodicity (in certain cases – especially the debt and liquid funds) of dividend and whether one wants to receive the dividend in hands or get the same reinvested. Reinvestment of dividend results in purchase of more units of the same fund.

The entire hierarchy is given below for a quick reference.

One must note that the dividend frequency options are not available across all types of funds or all schemes. A fixed frequency is not available in case of equity and balanced funds. The daily or weekly options are available only in case of liquid category of funds. Most of the times, there is no payout option in case of daily or weekly frequency and the dividend is compulsorily reinvested.

Which option should an investor opt for? Why?

The answer starts from the objective of the investor. For what purpose was the investment done? What is the goal that the investor wants to achieve through the said investment? Broadly, investors invest their money with one of the three purposes: viz. accumulation, regular income or temporary parking of surplus funds.

Among these three, what one should do with the dividends – whether to take payout or reinvest the dividend – seems quite obvious. Growth option seems logical for accumulation goal and dividend payout for regular income goal. If only life was so simple.

An important factor to consider is the tax treatment of the income as well as the tax status of the investor. Dividends from mutual funds are tax-free in the hands of the investor. However, in case of funds classified as non-equity funds, there is a dividend distribution tax charged on the quantum of dividend distributed to the investors. This tax is charged before the fund pays out the dividend to the investor.

On the other hand, if an investor has opted for growth option, the difference between sale price and purchase price would be considered capital gains. In case of equity oriented funds, gains booked after completion of 1 year from the date of investment are long term whereas those booked before completing one year are short term. (This period is three years in case of all non-equity oriented funds). The short term gains are added to the person’s income for the respective year and taxed at the marginal rate of tax applicable to the assessee for the year.

As can be seen from the above, the tax is likely to be higher on short term capital gains for an investor in a higher income slab. On the other hand, if an investor is in the tax-exempt category or one who does not have a source of income or where the income is below the taxable limits, it would be unwise to opt for dividend option even if there is a need to get regular income. The dividend distribution tax is applicable to all investors irrespective of the level of income.

The last two paragraphs are applicable more to debt and liquid funds than to equity funds. In case of equity funds, many investors perceive that dividend option is better than growth. The logic here is that the dividends are paid out when the fund has made profit. The sad reality is that the dividends may or may not be paid out in boom times when the fund is supposed to have made profits. Many investors expect the fund managers to be able to predict the market tops and thus payout dividends. Once again, the sad reality is that the history does not offer any evidence to the effect. It may be prudent to opt for growth option in equity funds if the time horizon is long, say 10 year or more. The growth option will allow the investor to benefit from the power of compounding.

Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions. He can be reached at amit@karmayog-knowledge.com