Liquid Fund — Dividend Reinvestment option

POSTED BY Ram Mohan ON May 1, 2012 8:42 am COMMENTS (16)

Dear Experts

I have a liquid fund with option “Dividend Reinvestment” — now my question is — am I just losing money here without any gains? The dividend that is reinvested is subject to DDT

I’m in 30% tax bracket. But if I sell off my holdings within 1 year I’ll have to pay short term capital gains tax.

So my question is are there any advantages at all in this “Dividend Reinvestment” option over growth at any point of time? (Meaning time of investing, redeeming, after 1 year, before 1 year etc). I simply don’t see the value in this

Thanks in advance,

Ram

16 replies on this article “Liquid Fund — Dividend Reinvestment option”

  1. Kumud Taparia says:

    I agree with Mr. Ram Mohan. I also don’t understand as to why people suggest that “Go for Daily Dividend Reinvest option if you fall in 30% tax slab.”

    I understand that NAV being same, there would be no capital gain. However, the DDT, though lower than normal tax rate, would still be a sunk cost for which nothing can be done.

    Perhaps, people giving this suggestion ignore two possibilities : 1. If the funds remain for 3 years for any reason, you can save tax under growth option which is not possible under Dividend Reinvestment 2. Possibility of set off with short term capital loss exists under growth option but not under Dividend Reinvestment.

    1. Hi Kumud Taparia

      Thanks for your sharing your valuable comment on this topic. Please keep sharing your views in future also

      Manish

  2. Ram Mohan says:

    @banyanfa — ok I get the “trick” now. Isn’t this possibly the same thing that is applicable in all dividend reinvestment options for other liquid funds?

    Another follow up question. Isn’t it a bit complex to calculate your actual profit in the dividend reinvestment scheme?

    I’ve decided to keep it simple by opting for growth option…

    1. Dear Ram, the taxation part is discussed at lengths already hence not touching that. Regarding calculation of profit, it’s very simple. Say you started with 10000 units & due to Div. reinvestment, total units are 11000. Now the difference between purchase price of 10000 units & sell price of 11000 units is your profit adjusted for STCG/LTCG Tax if any.

      Thanks

      Ashal

      1. Ram Mohan says:

        Dear Ashal,

        I think from a taxation point of view, the cost of acquisition should be for 11,000 units rather than 10,000 units. The reinvestment is also considered as cost of purchase because for the reinvestment amount, tax has already been paid

        Thanks,

        Ram

        1. Dear Ram, you are focusing on taxation issue, I simply provide the profit calculation.

          Thanks

          Ashal

  3. BanyanFA says:

    Hi,
    You are indeed correct. Full details of the DDT and tax impact of Liquid funds can be found at http://insight.banyanfa.com/?p=690.

    If you are in 30% bracket, any short term investment which you make shall attract 30% TDS.

    Other option, which is much preferred for high earners is to invest into HDFC Cash management Fund – Treasury Advantage Plan. While this fund’s returns are almost like a liquid fund, its dividend doesn’t attract a 27% + DDT. DDT in this fund is just 15% and hence if you are in 30% tax bracket, you are reducing your tax liability from 30% to just 15% DDT. You can invest in this fund with Dividend Re-inv option.

    Regards
    BanyanFA

    1. Muthu Krishnan V says:

      so this means if we have set-up a daily STP to any hdfc equity fund from hdfc debt fund, it would be advisable to set it up from hdfc cash management fund – treasury advantage plan – daily dividend reinvestment option (ultra short term) instead of HDFC Cash Mgmt Savings (liquid fund).

      This would be much more tax efficient?

      1. BanyanFA says:

        Hi Muthu,
        My point is that you should not go for a Dividend Reinv option (whether daily, weekly or any other frequency) from HDFC Cash Management- Saving Plan as DDT would be deducted. If you want HDFC CMF – Saving, invest it in Growth Option and do a Daily STP into Equity plan.

        Regards
        BanyanFA

        1. Muthu Krishnan V says:

          @BanyanFA,
          I agree with you. At present I have a STP from hdfc cash management fund (G) and hence I end up paying at STCG at 30%. It would be more efficient to set-up the STP from HDFC TAP – daily Dividend Reinvestment. The returns are more or less the same and the tax would be 13%+ instead of 30%. am I right?

    2. Ram Mohan says:

      @BanyanFa

      I don’t understand how HDFC Treasury Advantage plan – Dividend Reinvestment scores over HDFC Treasury Advantage Plan – Growth. Assume that my holding period is 1 year plus so that I have to only pay Long Term Capital Gains Tax on the same

      Thanks,

      Ram

      1. BanyanFA says:

        @ Ram Mohan.

        You are right, I am not advocating a Dividend Reinv for HDFC TAP if the holding period is more than 1 year. The entire discussion is for investment horizon upto 1 year. Before 1 year, a debt fund attracts STCG equivalent to the tax slab of the investor. Hence to summarise :

        Debt Fund – Short term – Go for HDFC TAP – Dividend Reinvest – applicable tax would be DDT
        Debt Fund – Long Term – Go for HDFC TAP – Growth option – applicable tax would be 10% without Indexation or 20% with Indexation.

        If the discussion is with regards to NRIs, then the above way of investing doesn’t hold good due to TDS implication. To avoid any confusion, I shall not detail that unless there are any NRIs who want this clarification.

        Regards
        BanyanFA

        1. Ram Mohan says:

          @BanyanFa — I’m not sure I still understand how dividend reinvestment option helps in case of short term. Let’s say I sell the units before 1 year, I still get taxed at my tax bracket, right? The DDT tax @ 15% is only for the reinvestment, but when I liquidate, I still have to pay 30% (my tax bracket) for all units if it’s done within 1 year, right?

          I’m officially confused!

          Thanks,

          Ram

          1. BanyanFA says:

            Hi Ram,
            I love your last sentence “Officially Confused” 🙂

            The answer lies in a small maths. When ever the fund declares the Dividend, its NAV drops. The dividend amount is then re-invested at this rate. Hence over a period of time, your units increase, but the NAV doesn’t increase. Hence, when you sell, your cost of acquisition is almost equal to your sell price – generating almost no capital gain.

            Another alternative is to go for dividend option – in case you want to keep things simpler.

            Regards
            BanyanFA

          2. Check out “Where to Park Short Term Funds/Emergency Corpus” under http://justgrowmymoney.wordpress.com/downloads/. You will see why dividend reinvestment scores over growth option for up to 1 year

  4. what was your idea when you opted for dividend re-investment? You are right DDT will eat away a portion of your profits. I guess you have an option to change it to growth.

    Give your fund time so that you are eligable for Long Term Capital gains.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Download Our FREE Ebook!

Available only for first 100 people today

Download Our FREE Ebook!

Available only for first 100 people today