What is a dividend plan in mutual funds?

In a couple of months, from April 2021 onwards, dividend plans in mutual funds will be history. As per new Sebi norms, dividends plans will be called ‘pay-out of income distribution cum capital withdrawal option.’ Similarly, the other two dividend variants - dividend reinvestment and dividend transfer plans - would also be renamed.

Are you wondering why Sebi has ordered mutual funds to change the name of dividend plans? Well, dividend plans in mutual funds were always a misnomer, say investment advisors. Most inventors typically associate the term dividend with the stock market. They think dividend is the same in stocks and mutual funds. However, this is not the case.

For example, when a company is declaring dividend , it is distributing profits among investors in its stock. The dividend is extra returns investors make on the price appreciation of the stock. Sure, a regular dividend paying company may see its stocks fetch more price in the market.

However, when it comes to mutual funds, dividend is nothing, but a part of the profits or money made by inventors. The mutual fund is simply distributing the profits among investors. And when it distributes profits, the NAV comes down by that extent, clearly showing you have taken money out of your investments.

Then why do investors opt for dividend plans while investing? One, convenience. If you are looking for regular income from your investments, it is a convenient way to get the money. Also, many investors think that it helps them to get some money out of their investments regularly, without realising they are actually pulling out profits from their investments. They also don’t realise that it will result in a small corpus over a long period.

This the reason why many mutual fund advisors used to ask investors to use the Systematic Withdrawal Plans or SWP to draw regular income from their investments. Advisors have been asking retirees to use the SWP-route than dividend to draw a regular income. Mutual funds can declare dividends only out of their profits. That means they may not declare dividends during a bad phase in the market. SWP can help investors to overcome the issue, say advisors.