Mutual Funds earn & can distribute money by 2 options. One is payment by way of dividends & the second way is – systematic withdrawal plans (SWP). But which option is suitable for you as an investor. Well, there is no one correct answer as the investor’s profile, taxation & requirement are unique. Let’s learn the advantages & disadvantages of Dividends or SWP.

What is a dividend in Mutual Funds?

The dividend is a way of distribution by mutual funds. Surplus can be distributed by lowering the NAV. Currently, SEBI in April 2021 has instructed this option to be called IDCW. ‘IDCW’ is an abbreviation of ‘Income Distribution cum Capital Withdrawal’.

SWP

SWP or Systematic Withdrawal Plan is a way of getting withdrawals at a predetermined date. The units are redeemed and paid to the investor. It is almost the opposite of SIP.

If investors want regular cash flow from their investments the automatic choice for many are bank fixed deposits or postal deposits. However in MFs also SWP is a facility, through which investors can withdraw fixed amounts at regular intervals, for example – monthly/ quarterly/ yearly from the investment they have made in any mutual fund scheme.

To generate this cash flow, SWP Plan redeems units of mutual fund scheme at the chosen interval. Investors can continue with SWP as long as there are balance units in the scheme.

So what is the difference? Can an investor gain if he/she prefers either of the options? Well SWP has many advantages over Dividends.

Dividends or SWP

When we see things in perspective for Dividends or SWP … it is Advantage SWP – Here is why:

Dividends are Not Assured

It looks like dividends are assured or regular but NO. The frequency or amount is not assured. These are regulations that dividends cannot be assured and they can only be communicated before 7 days of the record date.

Dividends can be declared only from realized gains. This means if the market is down or any other reason if the scheme has not appreciated it cannot declare dividends. If MF company wants they can share reserves (existing accumulated profits)

When markets go into correction mode, even if the AMC declares dividends from their Reserves created from past realized gains; the same may be coming from their principal i.e. Investors may be getting their own principal back in the form of dividends.

And, this is a risk for MF Company as these reserves can get depleted. The MF may not be in a position to declare a dividend in falling market scenarios in the future.

One of the big MF company, skipped declaring all 12 monthly dividends in their MIP during the 2008-2009 market meltdowns.

Those investors who need regular cash flows will then be at a total loss under such circumstances.

Dividend Option Investor miss Compounding

Fund Managers have to book profits forcefully, from time to time to declare dividends instead of holding onto these gains for future growth

Although profits are booked at the scheme level so both Growth & Dividend Options will have a surplus. In the growth option, this can be further reinvested.

But dividend option investors will get it back.

So, those who opt for regular dividend payouts; lose on the opportunity of creating future wealth as the power of compounding is lost on the funds repaid as dividends.

Requirement Fulfillment

A dividend since it is not assured you cannot tie a regular payment with it. Neither payment nor quantum is fixed. So you cannot plan something for it.

Sometimes you may get an amount more than you require or sometimes the amount may be short. It does not take care of inflation also.

Taxation – Dividends or SWP

And this is the final reason you should not opt for dividends if you fall in high tax brackets.

MFs deduct 10% as TDS on dividend payments. Also, it is taxable in hands of the investor. So if are in a low or NO tax bracket, you can benefit otherwise net gains are less.

In SWP, when units are redeemed to draw the SWP amount, it attracts capital gain. This capital gain is further defined as short term or long term as per the following conditions –

1. Equity /equity-oriented funds –

If redeemed within 12 months from the date of investment, these are treated as short-term gain and taxed at 15%. Gains made after 12 months from the date of investment are treated as long-term and tax-free up to Rs 1 Lakhs in a financial year. Long-term capital gains over Rs 1 Lakh are taxed only at 10%.

2. Non-Equity Funds –

If redeemed within 36 months (treated as a short-term capital gain) from the date of investment, the gains are added to the investor’s income and taxed at the rate applicable to him/her. Gains made after 3 years are treated as long-term and taxed at 20% after allowing indexation benefits.

So, you can see LTCG is may be lower than the high-income tax rate of 20% or 30%. Also, there is no TDS (Only NRIs have TDS on SWPs)

Hence SWP scores over when you analyze – dividends or SWP. What do you think? Share with me over email or the comments section below.