A mutual fund has just declared dividend and your broker has called you up asking you to invest in the fund.
Before you rush off to take out your cheque book to sign a cheque to give to your broker, wait. Don't be in a rush, as there is a dividend from a mutual fund house is a misnomer.
Here we take a look at what dividend is, why mutual fund dividend is not a true dividend and why investing just for the sake of dividend can make you poorer.
What is dividend?
Dividend is the income you earn from investment in shares or mutual funds. It is declared from the profits earned by the company or fund house.
What is the difference between dividend from shares and dividend from mutual funds?
Well, there is a lot of difference in dividend from shares and dividend from mutual funds. The dividend from shares is given from the profit of the company. It shows the company's robust performance and strong balance sheet.
On the other hand, dividend from mutual fund is declared only to reduce the NAV (Net Asset Value) of the fund. So once the fund house declares the dividend, the NAV falls by the amount of dividend declared.
For example, assume the NAV of the fund is Rs 100. Now it declares a dividend of 10%, i.e. Rs 10, per unit. Once the dividend is paid out, the NAV now becomes Rs 90 (original NAV - dividend declared).
On the other hand, dividend from share, does not affect its share price, which is actually decided by the market demand and supply of the company's stock. So if the company, whose share price is Rs 100, declares a dividend of Rs 10, it will not affect the company's share price. It may be Rs 80 or Rs 130 depending on the market circumstances.
My advisor has asked me to invest in a fund that has just declared a dividend. Should I go for it?
Unfortunately, many fund houses as well as brokers are familiar with the general attitude of people to earn easy money. So fund houses frequently declare a dividend in order to entice public to invest in their schemes.
This fact is misused by the brokers who use this fact to aggressively market this fund's scheme. They mislead the public by telling them that dividend from shares and dividend from mutual fund are same. This takes the gullible public for a ride, who end up investing in these schemes.
What are the drawbacks of investing solely for the dividend?
This approach to investing is fraught with many pitfalls. Here are some of them:
- Dividend from mutual fund does not help in capital appreciation, since the NAV of the fund reduces by the amount of dividend declared. This makes you lose out on the power of compounding.
- You could end up choosing the wrong fund, simply to earn dividend.
- If you are investing in a fund, just to earn dividend as income, you would be in for nasty surprise as these dividends are not guaranteed. In case the fund doesn't perform well, it may not declare any dividend.
Always understand the difference between the dividend from shares and dividend from mutual funds. Don't invest in the fund just for the sake of dividend. Rather, look at the fund from the viewpoint of your risk profile, your goal, the fund's performance, volatility and track record before investing in it.