Understanding Monthly Dividend Mutual Fund Schemes: A Comprehensive Guide

The term Monthly Dividend Mutual Fund Schemes refers to a financial instrument designed to provide income, primarily through regular dividend payouts. These schemes are particularly favored by investors seeking a regular cash flow. Below, we explore the features, benefits, and considerations of such funds, focusing on popular options and the alternative structure of Monthly Income Plans (MIP).

Popular Monthly Dividend Mutual Fund Schemes

Several reputable fund houses offer monthly dividend schemes, such as the Templeton India Equity Income Fund, the ICICI Prudential Dividend Yield Equity Fund, and the UTI Dividend Yield Fund. These funds, categorized as equity-oriented, offer moderately high returns, making them attractive for investors who are looking for a stable income stream combined with potential capital appreciation. However, it's important to note that monthly dividend schemes are not without risk and should be carefully evaluated.

Monthly Income Plans (MIPs): A Different Approach

Monthly Income Plans (MIPs) are a debt-oriented alternative to traditional mutual fund structures. Unlike dividend-based funds that distribute profits directly to investors, MIPs reinvest the income back into the fund, allowing the investor's money to continue to grow. This method is particularly attractive to investors who are less focused on immediate income and more on long-term growth and compounding returns. In this section, we explore the two main options available in MIPs: the dividends option and the growth option.

MIP with Dividend Option

The MIP with Dividend Option provides periodic income distributions. Here's how it works:

Investors can receive dividends monthly, quarterly, half-yearly, or annually, as per their preference. The fund declares dividends only from its profits and not from capital, ensuring that investors receive returns from earned income. Note that while dividends from MIPs are tax-free in the hands of investors, the fund pays a dividend distribution tax of around 14%. For example, if a fund declares a dividend of Rs 3 per unit, the fund has to pay 42 paisa as Dividend Distribution Tax, reducing the net income to the investor. Keep in mind that MIPs are also known to reduce their Net Asset Value (NAV) by the amount of the dividend paid, making it important to manage your expectations.

MIP with Growth Option

The MIP with Growth Option is designed to provide long-term growth without immediate income distribution:

The money is not paid out but instead reinvested in the fund, leading to compounding benefits as the returns earn money themselves. This option allows for greater flexibility and control over one's investment, as there is no direct interference with the investment strategy.

Key Features of Monthly Income Plans

Dividends from Dividends Leakage

Investors should understand that dividends in MIPs are declared only from the profits and not from the capital investment. This ensures that the company can only distribute returns from its earned income, not from the initial capital value. This regulation is in place to prevent companies from appearing to provide consistent income even when their performance is poor.

No Guarantee of Regular Income

It's important to recognize that there is no guarantee of regular income with MIPs. While the goal is to regularly declare dividends, this might not always be possible due to poor performance. There is no regulation or oversight to mandate regular dividend payouts, so investors should be prepared for occasional income gaps.

Influence by Interest Rates and Stock Market

Even though MIPs are debt-oriented, they are not invulnerable to market fluctuations. The debt portion of MIPs can be affected by interest rates, which inversely affect the NAV. When interest rates fall, the NAV rises; when they rise, the NAV falls. The equity portion of the fund helps to mitigate some of these risks, but there is a possibility of negative returns in extreme cases.

MIPs and Mis-selling

The high commission structure in MIPs can make them prone to mis-selling. Agents receive commissions ranging from 1-1.5%, compared to 0.5-0.75% in equity funds. This makes MIPs an attractive option for sales agents, which can lead to inappropriate or misleading sales practices. Therefore, it's crucial for investors to do their due diligence and make informed investment decisions.

Understanding the intricacies of Monthly Dividend Mutual Fund Schemes, including MIPs, requires a careful examination of their features, benefits, and the associated risks. Whether you prefer regular income or long-term growth, it's important to make informed choices based on your investment goals and risk tolerance.