I never liked the dividend option. The only time I preferred the dividend payout option was in ELSS so that there could be some cash flow created from an asset which was locked in and the cash could be re-invested in the same scheme with tax benefits. I used to be dead against the ‘re-invest’ option in ELSS – which has thankfully been abolished.

Dividend is something that a company pays AFTER it has paid taxes on its profits and keeping a portion for its own future use. We investors come from an ‘interest earning’ mindset – if we have a bond paying 8% coupon, we like to get Rs. 80000 per annum on a bond with a face value of Rs. 10,00,000. At the end of the day the bond issuer still owes us Rs. 10L at maturity.

Equity does not come with a “promise” or a “maturity date” – so when your shares worth Rs. 10L pays Rs. 30,000 as dividends, the price falls to 9.7L. It may recover the “dividend” or not depends on whether the market goes up or down! So asking for dividends in equity SHARES makes no sense (Modigliani Miller theory for the over initiated). So why do we seek dividends? Because we still think that when a company pays dividends, our capital is intact and growing. Remember Vanguard and Buffett both of them have said “You want dividends? Go and create them”. Go and sell the shares whenever you want, and you can get dividends, right? Even in the Indian context the market prices dividends well. If you see MNC with huge payouts, the PE is also high – maybe as a tribute to the rewarding system. The IRR on say a Nestle or a Colgate would be dramatically higher if you had reinvested the dividends. The Sensex would be 56000 vs 39000 if the dividends were re-invested. Even from a tax point of view, capital gains is better than dividends.

Now come to the even more stupid option of “Dividends” in mutual funds. Again it is not just the investor’s irrationality it is MF industry misusing a well understood word (the biggest criminal is Facebook using the word ‘friend’). Since 1993 I have been saying that the MF industry should call it “distribution” and not dividends. MF dividends are so clear – the nav falls by exactly the same amount as the dividend (paid out plus tax). STILL people opt for dividends. Then they made it worse – they introduced a LEVY on dividends – so they pay that too! Most irrational decision.

Try explaining this to retail investors (even IFA in some cases) and they do not accept it. Great. Hopefully those who are making the decision at least they should know this irrationality. Advisers too should realise that it is their job to keep the client happy, not make him a PhD in investing. One argument that I have heard is “it reduces the Sequence of Return Risk”. Actually it does not. I am of the Modigliani Miller school – dividends surely reduce price – and one should be indifferent about how a business funds itself – and what it does with its dividends. In fact dividends increase the SRR and does not reduce the risk.

The problem with economic theory is it is still a probability, and not certainty like physics or chemistry. So the chances are that even if you choose a Rupee as dividend over capital gains, you might be able to make your capital last longer than your physical life. If a client is able to understand what he/she is doing, that is fine. After all client happiness is far more important than what the client gets as a return – as long as it lasts more than his life time and meets all his goals.

However by opting for dividends instead of a swp (systematic withdrawal plan) you are going against the rationality of Buffett and Vanguard, Modigliani n Miller, Modern Portfolio Theory, etc.

Who knows? you maybe lucky and I could be rationally right. Hey you should be worried about your (your clients) happiness….baaki sab bakwas.