Mutual funds are becoming increasingly popular for the vast majority of the Indian population and for a very good reason. According to a survey, over 40% of the respondents stated their intentions to invest in equity and mutual funds in the near future.
If you’re looking for sheer growth and have a high-risk appetite, you have ultra growth funds. If you’re looking for annual cash inflows, you have debt and dividend funds that will take care of your needs.
However, if you’re looking for lower-risk investments (when compared to ultra-growth funds) while taking full advantage of the power of compounding, then Dividend Reinvestment Plan (DRIP) is made just for you.
Dividend Reinvestment Plans, commonly abbreviated as DRIP, allow you to automatically reinvest proceeds from dividends into additional shares of the company/units of the mutual funds. Usually, there will be a hard limit on how many shares can be purchased in each transaction. This allows shareholders to utilize the power of compounding, by accumulating additional shares over time (which in turn will generate dividends, which can be reinvested).
Usually, when dividends are paid out, shareholders receive that money in their bank accounts as direct deposits, or in their brokerage accounts as the case may be.
However, in the case of DRIPS, the money will be automatically converted into additional shares of the company. Sometimes, these additional shares may even be issued at a nominal price/discounted price (when compared to the market value).
These plans are particularly common with shares that offer a high dividend yield.
There are four major types of DRIPs that are commonly available to the investing public.
Dividend Reinvestment Plans offered directly by the company.
Dividend Reinvestment Plans offered by third-parties, usually in exchange for a commission
DRIPs that make it mandatory for the dividends to be reinvested in the form of shares.
Dividend Reinvestment Plans that allow the shareholders to re-invest, only at their own discretion.
Here are some benefits of Dividend Reinvestment Plans as a shareholder:
Not only is your base investment’s market value appreciating over time, but you can also invest in additional shares through the excess income received, creating a huge compounding effect. Over years, the returns from a Dividend Reinvestment Plan can snowball, allowing your investment to see significant returns.
On the flip side, Dividend Reinvestment Plans come with their own share of negatives as well:
Usually, when you stay invested and do not liquidate your investments, you won’t be subject to any taxes. Typically, these gains that you’d make on paper would be called “unrealized capital gains”, and as such wouldn’t attract any taxes.
However, with Dividend Reinvestment Plans the tax treatment differs.
Tax treatment of DRIPs is similar to when you actually receive your dividends in the form of cash through your brokerage account. It will be subject to a Dividend Distribution Tax of 15%. The company will deduct 15% before distributing the dividends.
Instead of getting the money, and then reinvesting the money into the same company, you’re directing the company to keep the money in lieu of shares.
Like any other investment instrument, Dividend Reinvestment Plans also come with their own share of positives and negatives. Ensure that you conduct your own research, understand all the risks and benefits involved and invest only when you’re absolutely satisfied with the instrument.
For more information about investments, particularly in Mutual Funds, visit the Navi Mutual Fund. We’ve taken it upon ourselves to build a knowledge base, that will help investors to make informed investment decisions for themselves.
Disclaimer: Mutual Fund investments are subject to market risks, read all scheme related documents carefully before investing.
Ans: The Cost of acquisition of your initial purchase is the amount you originally invested. Further acquisition through DRIPs will be made at the discounted price/market value, as offered by the company.
Ans: Yes, several mutual funds players do offer Dividend Reinvestment plans. The amount of the dividend supposed to be distributed to individual investors is used by the AMC to purchase additional shares, at their discretion. Works extremely similar to a direct, mandatory dividend reinvestment plan offered by a company.
Ans: Each purchase of shares will be treated as a separate transaction, for the purpose of taxation. If your period of holding is more than one year, you will attract only the reduced rates of Long Term Capital Gain. However, if any of your recent Dividend repurchases happened within the last 365 days, to that extent, you will be eligible to pay the 15% rate of Short Term Capital Gain.
Ans: Gains from liquidating your investments – Income from Capital Gains.
Dividend income, (for companies which are not liable to pay Dividend Distribution Tax), – Income From Other Sources
Ans: Conduct your own research, and come to a logical conclusion based on your financial situation.
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