Earning a Regular Income with Dividend Mutual Funds

Mutual funds provide an easy platform for amateur and seasons investors to invest in equities and debts with the help of an expert. The fund manager of the Asset Management Company (AMC) makes an investment decision on behalf of the investors.The profits generated from the investments are distributed among the investors after deducting the expenses incurred, also known as the expense ratio.

1. It can be distributed to the pool of investors proportionately as per their share of investment.2. It can be added back to the total pool of investment for compounded capital growth of the investor.The first one is known as the Dividend option, often denoted by (D), in front of the mutual fund. The latter is known as the Growth option, often denoted by (G).Choosing the right option would depend on your financial goals. Investors who wish to earn a regular income from their investment would need to opt for a Dividend option. For those who are looking for capital appreciation, the Growth option would be a better way to go.

Investing in a mutual fund is a great way to appreciate your capital without actively making investment decisions daily. The fund manager does it for you, keeping the best interest of its investors in mind.
Not just capital appreciation, mutual funds are also an excellent way to earn regular income.If you wish to earn a regular income from your mutual fund investment options, you will have three options to choose from.

With the dividend option, the profits generated are distributed among the pool of investors proportionately depending on the number of units they hold. You can either choose to use the dividend earnings for your expenses or re-invest it to maximise your returns. The dividends are paid out as and when announced by the AMC.

Types of Dividend Mutual Funds

When choosing Dividend Option mutual funds, you can opt for three types of funds;

● Equity Funds

These funds invest majorly in equities and related instruments to generate returns for its investors. As they are subject to market volatility, they carry a high-risk possibility but are also known for their high-return potential. Equity funds are better suited for long-term capital appreciation than earning dividends regularly.

● Debt Funds

These funds invest predominantly into debts, bonds, government securities etc. They usually come with a fixed duration. These funds are better suited for earning regular dividends as the earnings are more predictable.

● Hybrid Schemes

These funds invest in a mix of equities and debt instruments to provide both security and capital appreciation for its investors.
Pros and Cons of Choosing the Dividend Option Pros a) If the AMC announces a Dividend, it is a sign that your investment is producing positive results. This makes it easier for you to track your investments.b) Dividends can help you generate an additional income. Cons a) Opting for the dividend option means you don’t get the benefit of compounded growth on your capital.b) The announcement of dividend is at the sole discretion of the fund manager, making it less predictable.

Dividend Distribution Tax (DDT)

The budget of 2020 demolished the DDT wherein the AMC had to deduct the DDT before making the payment to the investor. Now, the dividends would be added to your income, and you’ll be taxed as the tax slab based on your net taxable income.

SWP is an option which allows you to withdraw funds from your investments periodically. You can set this period annually, semi-annually, quarterly, or monthly. Based on the amount you choose to withdraw, the units from your investment will be reduced as per its NAV (Net Asset Value) on the day of the withdrawal.Choosing this option can be a great way to earn a regular income from your investments. Here are some of its pros and cons. Pros a) It is more predictable and hence more reliable than the dividend optionb) It allows the investor to take advantage of the rupee cost averagingc) Since the withdrawals include both capital and an interest component, it helps in more efficient tax planning. Cons a) SWPs eat up your fund units leading to capital depletion. This becomes worse when the market enters a bearish phase. Withdrawing your units at the reduced NAV can hurt your overall portfolio negatively.

MIPs are debt funds that invest about 70-80% of its funds into debt instruments, and the rest may be invested in equities and related instruments. These are open-ended schemes with no fixed duration. The investments are made to produce steady returns and generate a monthly income for its investors. Pros a) They are known to offer better returns than pure debt instruments such as FDs.b) These funds don’t come with any lock-in period making them liquid.c) A portion of the returns is guaranteed, ensuring predictable returns for the investor. Cons a) Since they invest predominantly into debt instruments, the returns are usually lower than equity-based funds.b) Since they are debt-funds, the gains are taxed as short-term gains if the fund is held for less than 3 years.

Mutual funds can be an excellent way to compliment or even supplement your monthly income. However, withdrawing your funds can lead to capital erosion. Thus, it is important to identify if your goal is to appreciate the capital or earn a regular income. Earning a steady income from investments can be a great option for people who are retiring or nearing their retirement age.However, it is essential to know how mutual funds work and choose the right method to earn regular income which leads to least capital erosion. Consider consulting an expert to design a robust portfolio that aligns with both short-term and long-term financial goals and is in tune with your risk appetite.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.