It’s almost vacation season and you are on a long break from your studies or work. Busy in streaming the best shows on Youtube with your favorite snack alongside. And here comes the best part of the episode, Damon Salvatore is showing his best moves as a killing vampire. And duh!! Here comes an ad about your investment decisions and their importance. Now, instead of enjoying the show you are worried about your investment decisions or in a plan to start an investment but have no idea how it works. We have got it covered!
Suppose that you invest in a mutual fund in a desire to plan for your retirement period. You must be wondering how you make the money when the fund itself buys and sells stocks and bonds. The answer lies in two key concepts: dividends and capital gains. So, in this particular blog, we will cover the importance of Dividends And Capital Gains In Mutual Funds. Let’s begin!
Deciphering Dividends: What Does It Mean In Simple Terms?
To make you clearly understand the meaning of dividends, I’ll take you to a scenario where I want you to imagine yourself as a bakery owner. Every month, your bakery makes a profit in the form of earnings. After paying for expenses like flour, rent, salaries, and reinvesting in the bakery such as a new oven, and a bigger storefront, you are left with some extra money.
Now, you choose to give some of this extra money to the people who bought shares of your bakery. This part of the money you give to investors is called a dividend.
Well, before going any further let me explain that dividends are related to a small share of the profits that the company that you invested in is giving to you. Dividends are a little bit like the extra few dollars the company you invested in gives back to you from its profits. The cash paid will depend on the amount of the profit earned by the company as well as on the number of shares purchased by you.
Here’s an example:
- Let’s say each share of your bakery is worth 100 Rs.
- If the bakery decides to distribute a dividend of 5 Rs. per share, and you own 50 shares, you would receive 250 Rs. (50 shares * 5 Rs. per share dividend).
Similarly, in the case of mutual fund investing, things also operate in a rather similar manner. This is the case where a mutual fund invests in companies that distribute dividends to their stakeholders, it in turn distributes the same dividends to its shareholders depending on the number of shares that they hold.
Need Of Dividend In Your Mutual Funds
- Cash Flow: As a result of passive income, when the companies the mutual fund invests in distribute their profits to shareholders, it is also given to the mutual fund. These are then split and passed to you the investor in the mutual fund. It means that one is receiving money frequently in rupees, which can be utilized for a variety of things required.
- The money you get from the dividend is actually your money which you as the mutual fund owner get to decide what to do with it. The cash can be received in your hand which can also be used to add up to your retirement fund or you can decide to reinvest it. Reinvestment of dividends is a method through which you acquire more shares without necessarily having to purchase them. That’s why with a Thrivent Mutual Funds account you can arrange for it to do it for you.
- Without reinvesting the money you get from dividends, the only way for your account balance to go up would be to put more money into it, or if the prices of the stocks and bonds in the fund go up.
Deciphering Capital Gains: What Does It Mean In Simple Terms?
Capital gains refer to the profit you make when you sell an asset for more than you purchased it for. In the context of mutual funds, this asset is your mutual fund unit. Here’s an example to illustrate:
Imagine you’re investing in a mutual fund that focuses on Indian stocks.
- You invest ₹10,000 in this mutual fund, buying units at a Net Asset Value (NAV) of ₹10 per unit. This means you own 1000 units (₹10,000 / ₹10 per unit).
- Over a few years, the companies the mutual fund invests in perform well, and the NAV of the fund increases to ₹20 per unit.
Now, let’s say you decide to redeem your units. Here’s how capital gains come into play:
- You would receive ₹20,000 (1000 units * ₹20 per unit NAV).
- Since you bought the units for ₹10,000 and redeemed them for ₹20,000, you’ve made a capital gain of ₹10,000 (₹20,000 selling price – ₹10,000 purchase price).
Need Of Capital Gains In Your Mutual Funds
- Suppose your goal is the constant increase of your capital, then capital gain might be helpful. Moreover, the return on investment that results from holding the stocks for a long, and reinvesting your capital gains is multiplied by compounding.
- Basically, mutual funds may be used in terms of saving for retirement. Stock market fluctuation can be better managed if the money is for a long-term investment say 10 years and above since more money can be made from the investments through value addition.
Important Tip: Remember that capital gains are not always assured for a greenhorn and speculated that one may not always end up in the black when trading the stock market, which fluctuates greatly. However, if you select the mutual fund that corresponds to the amount of risk that you are comfortable with and your investment goals, you stand a better chance of achieving any financial goals you intend to meet.
To clarify, that is the profit that you get once you have sold your mutual fund shares at a higher price than the purchase price. The longer that you hold your shares the more of a return on your money you can gain. Reinvestment of your profits can help your money grow much faster still.
Dividend And Capital Gain Distinction Covered!
If I have to conclude this differentiation in a nutshell I would say ‘Dividends are for income’ as they provide a steady flow of cash but ‘Capital Gains are for growth’ as they help your investment value grow over time.
On Parting Note!
On a final note, I’d say that both dividends and capital gains are significant components of understanding the performance of your mutual funds. Once you familiarize yourself with such concepts your decisions regarding investments will become more informed. But a point to remember is that always consult a financial advisor who will give you personalized guidance.
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Disclaimer – This article is for educational purposes only and by no means intends to substitute expert guidance. Mutual fund investments are subject to market risks. Please read the offer document carefully before investing.
