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Investment in Mutual Funds Research Team | Posted On Tuesday, April 07,2009, 11:51 AM

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Investment in Mutual Funds



We have read in a lot of places where advice is given that if a person requires regular income she/he should select for a dividend scheme. There is no balanced basis for this advice in case of equity-oriented mutual funds.

The explanation is that there is no set schedule of payment of dividend. Also to a great extent dividend will be paid is not predictable. And if a person needs cash flow, she/he cannot depend on the unpredictability of when and to what extend dividend will be declared for her/his regular need.

If this was not the reason for not selecting for a dividend scheme, then what is? Here we would like to ask a simple question. Why do you invest money in a mutual fund in the first position? Is it for the dividends or for the returns? If your answer is returns and that is your objective, then the decision to opt for the option should be based on the objective of making maximum return, be it either through the dividend option or through the growth option.

To enable you to make the best decision you need to understand the taxation aspect involved when a mutual fund scheme declares dividends. Investors should select for an option that minimizes their tax liability. Presently dividend income from equity mutual funds is tax-free; also there is no dividend distribution tax.

Secondly, long-term capital gains (all gains arising after sale of units held for more than one year) are also tax-free. In such an circumstances, if the investor plans to invest for a time period of less than a year then dividend option seems better (as you won't have to pay in tax in case you sell your units). But here, let us point out that equity as an asset category is for long term investing (say a 5 year horizon is good in current scenario). Hence investing in a mutual fund for less than a time period of one year does not make financial logic because returns would be lower.

Therefore if you are really a serious investor into equity mutual funds your perspective should anyways be greater than one year and hence growth preference would be more suitable as long term capital gains tax is nil.

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