When the interest rate on bank fixed deposit (FD) was declining, Ramesh Gupta, 70, switched his money to a balanced mutual fund on the advice of his friend. It turned out to be a wise decision as he was paid the income of 3 per cent every month on his investment. His fixed deposit was paying him only 6 per cent per annum, and that too taxable. The party, however, didn’t last for long, as after the recent decline in the stock markets, his dividend income has fallen significantly.

Gupta represents thousands of investors who invested in balanced funds attracted by its rich dividend payment history. These are people who in the last one year have seen a correction for the first time. Investing in the balanced fund as an option against FD could, however, prove to be a costly mistake for them if the markets continue to fall further.

Data compiled by ValueResearch shows that almost all balanced fund schemes have reduced their dividend outgo over the last couple of months. For example, HDFC Prudence Fund which had been giving a dividend of 3 per cent consistently for more than 2 years, since April 2016, for the first time reduced it to 2.66 per cent in the month of April and May.

Similarly, ICICI Balanced Advantage Fund gave the dividend of 2.5 per cent in the month of March, but for the last two months it has now come down to just 0.89 per cent .

The trend has been same across mutual fund schemes as dividend income for investors in Kotak Equity Savings declined to 0.36 per cent from 0.48 per cent in the month of May.

Tata Hybrid Equity scheme which gave the dividend of 7.2 per cent in the month of February has also reduced the dividend outgo from 6.7 per cent in March to the current rate of 5.76 per cent.

What decline in dividend rate means for investors? To make it simple, if the person had invested Rs 10 lakh in the scheme, then his monthly dividend income has come down to Rs 26,600 against the earlier dividend income of Rs 30,000 per month.

Aashish P. Somaiyaa, managing director and chief executive officer of Motilal Oswal Asset Management Company, says, “The finance budget for FY19 has introduced a tax of 10 per cent on dividends from equity-oriented funds. As a result the net dividend has surely declined.”

He adds, “As regards dividend declarations in future one must note that by regulation dividends can be paid only from realised gains and not just from appreciation which is yet unrealised. But the way the accounting rules prevail currently every inflow is automatically compartmentalised into unit capital, booked gains and unbooked gains. Hence, dividends declared even when funds are not gaining or dividends declared amidst falling NAVs are surely being paid from capital and not from gains. Predicting which way they are headed is not possible.”

The money started flowing in balanced funds on the back of the spectacular performance of the stock markets in 2017. The National Stock Exchange (NSE) gave a whopping return of 22 per cent last year, with nine out of 10 ending in black. Since the start of 2018, however, the picture has not been so rosy, as the NSE has given a return of just 3 per cent during the period.

Accordingly, AUM of balanced funds has also grown by leaps and bound during the last one year on the promise of regular monthly dividend in a non-guaranteed product. Banks and advisors sold balanced funds mindlessly during the last couple of years boasting about its consistent dividend payment history.

Shweta Jain, founder, Investography, a wealth management company, said, “Balanced funds take exposure to equity which is a volatile asset class in the short term and grows in the long term. So, when this category started giving regular dividends, it was a matter of concern. This category is not meant for regular income and dividends but for long-term growth.”

The worst is the fact that senior citizens lapped up the scheme most on the promise of regular income. They were not explained about the risk of investing in equities, which are subject to vagaries of the stock market. But with the markets turning volatile now people have started feeling the pinch in the form of declining monthly income from dividend plans.

What to do?

From May 2018 Securities Exchange Board of India (SEBI) has ordered recategorization of schemes, so there are changes in name as well as scheme objective (in some cases). It is, therefore, investors are advised to double check them before continuing with their existing investment.

Jain says, “Some funds have changed a lot and hence investors should definitely relook at the new vs old allocation so that they know what kind of fund they are invested in now and if they would like to stay invested or exit and realign the portfolio with their goals, more accurately.”

Moreover, the stock market volatility is here to remain as state and centre elections are due next year. Crude prices are on higher side, GST collections are average so slippage in fiscal deficit looms ahead, Any uncertainty arising from these elections will have a direct bearing on stock market volatility.

For their regular income, investors should do STP (Systematic Transfer Plan) from debt funds and also keep funds in liquid or short-term funds.

Somaiyaa says, “It puzzles me why people are unable to see the returns on their equity-oriented investment as being different from their need for cash flow. People sacrifice returns because they want cashflows or they sacrifice cashflow hoping for higher returns.”

He adds, “The best strategy is to invest in a dynamic equity oriented fund and give a pre-set instruction so as to receive the required cash flow on monthly basis. If the long-range return is expected to be 12 per cent CAGR and if we set an instruction to receive say 0.75 per cent per month by way of systematic withdrawal and we remain invested for 5-10-15 years post retirement I don’t see how one can go wrong. “

Investors, especially senior citizens like Gupta, who do not have any other source of income, should understand the risks involved in equities before getting swayed by high return.