How to calculate returns from Dividend Mutual Funds?

In this post, let us consider how to calculate returns from ‘dividend’ and ‘dividend reinvestment’ mutual funds.

This post represents an understanding of an issue which has always troubled me since the (first) manual version of mutual fund tracker (notice the frequent revisions).

I thought I finally had it right in the automated version, until  Mr. Deepak Rao wrote in saying that the way dividends were handled for CAGR calculation in the tracker was wrong.

He was kind enough to share his understanding of how mutual fund dividends must be accounted for, and sent his account statements for me to work on.

The following post and the subsequent corrections to the automated tracker would not have been possible without his efforts.

Unfortunately, the bad news is that existing users of the tracker who use dividend option mutual funds will have to download the new one from trackers main page.

I apologize for this inconvenience.

Now, on with the explanations. This article is based on the NCFM Advanced Mutual Fund Module. The study material referred for this post is from here (Chapter 6, section 6.1)

Warning: The following is some heavy stuff. If you don’t find the following arguments confusing at first, something is wrong with you!

If you are not interested in details, then please proceed to downloading the latest version of the automated mutual fund and financial goal tracker.

If you are interested in how stock dividends should be accounted for while calculating returns, see: Understanding the Nature of Stock Market Returns

If you are interested in this subject matter, you have no option but to read and re-read the following to obtain clarity. I will be delighted if you could take the trouble of reading this and share your thoughts in the comments section.

I Mutual Funds with ‘dividend' payout option

In this case, fund houses offer dividends from time to time when they have enough to disburse. When a dividend is declared, the net asset value (NAV) decreases by an amount equal to the dividend rate – (typically few rupees per unit).

This lower NAV is known as Ex-dividend NAV

(Ex-dividend NAV + Div. Rate = Cum-Dividend NAV)

There are many ways of calculation returns from dividends, and there is enough confusion and debate on this. However, SEBI has mandated that dividends should be deemed as reinvested at ex-dividend NAV for calculating returns.

So we will just use this convention.

The essential idea is that, while calculating returns only the actions of the investor must be accounted for explicitly. A dividend is an action by the instrument and should only be accounted for implicitly.

Since my understanding is entirely based on the NCFM module, I will simply use the dates they use. The discussion here is however considerably different from the one there.

Let us consider the following example.

 Consider the following actions taken by an investor

div-investor

  • Rs. 14,000 invested in a fund at a NAV of 14 on 15-Jan. 2011. Units: obtained: 1000
  • On 01-Jul-2011, the fund declares a dividend on Rs. 2 per unit. Dividend received Rs. 2000
  • On 10-Dec.-2011, the fund declares a dividend of Rs. 1.5 per unit. Dividend received Rs. 1500
  • On 01-Feb-2012, The 1000 units are sold at a NAV of 14.85. Amount received Rs. 14,850.

How do we calculate the return for such a scenario?

Now, there are two ways to do this:

  • Using Excels XIRR function
  • Using the formula for CAGR

return = [total-value/investment]^(1/duration in years) -1

Let us start with the XIRR function.

Let us recall that dividends are assumed to be reinvested. So

  • On 15-01-2011, investment of Rs. 14,000. Total units = 1000.
  • On 01-07-2011, a dividend at the rate of Rs. 2 per unit was declared. So dividend = 2 x total units  = 2 x 1000  = Rs. 2000
  • This dividend is assumed to be reinvested at ex-dividend NAV of 12.5 (on 01-07-2011). Units ‘purchased’ = 160. Total units 1160
  • On 10-12-2011, a dividend at the rate of Rs. 1.5 per unit was declared. So dividend = 1.5 x total units = 1.5 x 1160 = Rs. 1740 (this is entirely imaginary used only for calculating returns)
  • This is the key step that eluded me previously. Any dividend should be calculated by assuming all past dividends are reinvested. This should reflect in the total units
  • So this imaginary dividend of Rs. 1740 is assumed to be reinvested at ex-dividend NAV of  13.594 (on 10-12-2011). Units ‘purchased’ = 127.998. Total units = 1160 + 127.998 = 1287.998
  • On 01-02-2012, these (imaginary) units were redeemed at a NAV of 14.85. So redemption amount is 19126.77

Implementation in Excel using XIRR

This can be a bit tricky. Dividends are assumed to be reinvested and this must reflect in the maturity value. However, a dividend is considered as an action by the instrument and not by the investor. Therefore such actions should be not explicitly included as part of the cash flow!

I know that sounds confusing! Join the club.

Here are two ways to implement this in Excel. Both will give you the same answer for the return = 34.74%

XIRR-div-payout

On the left, an additional cash flow entry is include – the value today. On the right this term is omitted.

Since all the units have been redeemed, whether you calculate returns today or as on 01- Feb-2012, the answer is the same, as it should be. This is the advantage of XIRR.

Implementation using CAGR

Here again, we assume that dividends are reinvested but do not explicitly include in as as cash flow entries.

We invested Rs. 14, 000 and we got Rs. 19,126.77, 382 days later

So  using, CAGR = [total-value/investment]^(1/duration in years) -1

We get CAGR = [19126.77/14000]^(365/382) -1 = 34.74%

So we obtain the same answer as the XIRR function. Well, not quite! This is the return 382 days after investment. That is on 01-Feb-2012.

Try answering, what is return today (11 Apr 2014), that is after 1182 days after the investment?!

You will immediately agree that XIRR is a better and simpler choice! In any case, if the investor makes multiple purchases or redemptions, only XIRR can used.

Summary: For mutual funds with ‘dividend’ payout option, the dividends are assumed to be reinvested at ex-dividend NAV. Such ‘reinvestments’ must reflect in the ‘value’ of the investment. However, dividends are considered to be actions on part of the instrument and not the investor. Therefore, they should not be accounted for explicitly in the cash flow.

II Mutual Funds with ‘dividend reinvestment’ option

For such instruments, the dividends are actually reinvested by the investor on the dividend date at ex-dividend NAV!

So we have two actions here:

  • The dividend: action by the instrument and to be taken into account implicitly as above
  • The dividend reinvestment: action by the investor. This results in an actual increase in number of mutual fund units held. Therefore, this must be explicitly taken into account in the cash flow.

Consider the following actions taken by an investor

div-reinv-investor

  •  Rs. 14,000 invested in a fund at a NAV of 14 on 15-Jan. 2011. Units obtained: 1000
  • On 01-Jul-2011, the fund declares a dividend on Rs. 2 per unit. Dividend received = 2 x 1000 = Rs. 2000 as dividend.
  • This is (actually) reinvested in the fund at ex-dividend NAV of 12.5. Units received: 160; Total number of units: 1160
  • On 10-Dec.-2011, the fund declares a dividend of Rs. 1.5 per unit. Dividend received = 1.5 X 1160 = Rs. 1740 as dividend.
  • This is (actually) reinvested in the fund at ex-dividend NAV of 13.594 Units received: 127.998; Total number of units: 1160 =127.998 =1287.998
  • On 01-Feb-2012, All 1287.998 units are sold at a NAV of 14.85. Amount received = Rs. 19126.77

In this situation, there are 3 actual purchases. So the CAGR formula cannot be used. One will have to use only the XIRR function.

Here is how the above investor actions will be accounted for, when we set out to calculate returns (take a deep breath!)

  • 15-Jan. 2011: Rs, 14,000 invested. Units obtained: 1000
  • 01-Jul-2011: Dividend of Rs. 2 per unit declared. Dividend received: Rs. 2000
  • This dividend is assumed to be reinvested on the same day at ex-dividend NAV of 12.5. Units ‘purchased’ = 160. Total units 1160.
  • The dividend reinvestment done on the same day is an action by the investor leading to purchase of actual units. Therefore, this has to be explicitly accounted for.
  • Dividend reinvestment: Rs. 2000 at NAV of 12.5. Actual units purchased = 160. Total units: 1160 + 160 = 1320. 
  • 10-12-2011: Dividend of Rs. 1.5 per unit declared. Dividend ‘received’: 1320 X 1.5 = 1980 (notice that this imaginary dividend is different from actual dividend of 1740). 
  • This dividend is assumed to be reinvested on the same day at ex-dividend NAV of 13.594. Units ‘purchased’ = 145.652. Total units: =1320 + 145.652 = 1465.652. 
  • Again the dividend reinvestment is an investor action. So we will have to use the real dividend value of  1740 for the investment
  • Dividend reinvestment: Rs. 1740 at NAV of 13.594. Actual units purchased = 127.998. Total units: 1465.652. + 110.343 = 1593.650
  • 01-02-2012: Since the investor redeemed all units, all the imaginary units are assumed to be redeemed at NAV of       14.85. Redemption amount: 23665.705

Again, here are two ways to implement this in Excel. Both give the same answer for the return = 36.84%

XIRR-div-reinv

On the left, an additional cash flow entry is included – the value today. On the right this term is omitted.

Since all the units have been redeemed, whether you calculate returns today or as on 01- Feb-2012, the answer is the same, as it should be.

Summary: For mutual funds with ‘dividend reinvestment’ option, we will need to deal with dividends and dividend reinvestments separately.

  • Dividends are actions by the instruments and are assumed to be reinvested. They are not explicitly taken into account as a cash flow entry
  • The dividend reinvestment is an actual investment leading to an increase in the number of units held. So this has to be explicitly accounted for as a cash flow entry.
  • Both dividends and dividend reinvestments must be taken into account for XIRR calculation.

This method of accounting for dividends and dividend reinvestments has been incorporated in the current version of the automated mutual fund and financial goal tracker.

I would appreciate your feedback on this post. If you are an expert and disagree with any of the above, please do spare a few moments to let me know your concerns.

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44 thoughts on “How to calculate returns from Dividend Mutual Funds?

  1. bharat shah

    whether i understand the post subject matter or not , but i think , the premise of presuming dividend pay out invested in the same fund seems not logical. yes , it may be o.k. for point of the mutual fund concerned to arrive its xirr , but for point of view of investor , it is not so. its story ends there , when he gets the a/m back , whether as redeemed or as dividend. he has all rights how to use it , may be with better return or less, or he may spend it. when you are preparing mf portfolio return calculator, it should give the return of a/m invested and the period of investment.there is no question of upto today, which a/m got back earlier.

    Reply
    1. pattu

      Here we are talking about the performance of the fund and not of the investor. So wrt the dividend has to be taken as reinvested. Wrt to investor, only they can answer that!

      Reply
      1. Vikas Bansal

        I have the same comment as Mr. Bharat Shah. Have read Mr. Pattu's response to the same. Below points may help:
        1. Any dividend received by an investor is equivalent to redemption of equivalent units of the scheme.
        2. To Mr. Pattu's comment 'Here we are talking about the performance of the fund and not of the investor. ' - I plan to use the MF Tracker to track the performance-of-my- portfolio and not that of the MF scheme(s). If I plan to use the MF Tracker correctly then I think the goal should be to track the-performance-of-the-portfolio-of-the-investor and not the-performance-of-the-fund.
        3. Taxation - it is my understanding that dividend returns from equity MFs are tax free - at both the ends - the AMC as well as the investor. In fact this is the primary reason I choose dividend option. If I were to not choose the dividend option and instead choose the growth option AND redeem units equivalent to the dividend declared by the AMC (for the corresponding Dividend option of the same scheme) then I'll have to pay short term capital gains tax (15%).

        Would be keen to know views on the above.

        Reply
        1. pattu

          Hi Vikas,

          1) Yes "Any dividend received by an investor is equivalent to redemption of equivalent units of the scheme" and hence must be treated as reinvested for returns calculation. Of course in reality the number of units do not change

          2) Tracking fund and tracking folios are separate but important tasks. Even while tracking folios, the fund performance may need to be checked

          3) Divided from equity MFs are free from an tax. For debt funds, the amc will deduct DDT and then the dividends are tax free in the hands of the investor.
          If you choose growth and redeem, whether they correspond to dividends or not, taxation will depend on age of units and according to which will qualify for long term (> 365 days) or short term (<= 35 days) gain.

          Reply
        2. bharat shah

          thank you for comment . i think , it clears my point. the tracker is w.r.t. investor's investment ,so it should be considered like that. however i have no argument against shri pattu's view point.

          Reply
  2. bharat shah

    whether i understand the post subject matter or not , but i think , the premise of presuming dividend pay out invested in the same fund seems not logical. yes , it may be o.k. for point of the mutual fund concerned to arrive its xirr , but for point of view of investor , it is not so. its story ends there , when he gets the a/m back , whether as redeemed or as dividend. he has all rights how to use it , may be with better return or less, or he may spend it. when you are preparing mf portfolio return calculator, it should give the return of a/m invested and the period of investment.there is no question of upto today, which a/m got back earlier.

    Reply
    1. pattu

      Here we are talking about the performance of the fund and not of the investor. So wrt the dividend has to be taken as reinvested. Wrt to investor, only they can answer that!

      Reply
      1. Vikas Bansal

        I have the same comment as Mr. Bharat Shah. Have read Mr. Pattu's response to the same. Below points may help:
        1. Any dividend received by an investor is equivalent to redemption of equivalent units of the scheme.
        2. To Mr. Pattu's comment 'Here we are talking about the performance of the fund and not of the investor. ' - I plan to use the MF Tracker to track the performance-of-my- portfolio and not that of the MF scheme(s). If I plan to use the MF Tracker correctly then I think the goal should be to track the-performance-of-the-portfolio-of-the-investor and not the-performance-of-the-fund.
        3. Taxation - it is my understanding that dividend returns from equity MFs are tax free - at both the ends - the AMC as well as the investor. In fact this is the primary reason I choose dividend option. If I were to not choose the dividend option and instead choose the growth option AND redeem units equivalent to the dividend declared by the AMC (for the corresponding Dividend option of the same scheme) then I'll have to pay short term capital gains tax (15%).

        Would be keen to know views on the above.

        Reply
        1. pattu

          Hi Vikas,

          1) Yes "Any dividend received by an investor is equivalent to redemption of equivalent units of the scheme" and hence must be treated as reinvested for returns calculation. Of course in reality the number of units do not change

          2) Tracking fund and tracking folios are separate but important tasks. Even while tracking folios, the fund performance may need to be checked

          3) Divided from equity MFs are free from an tax. For debt funds, the amc will deduct DDT and then the dividends are tax free in the hands of the investor.
          If you choose growth and redeem, whether they correspond to dividends or not, taxation will depend on age of units and according to which will qualify for long term (> 365 days) or short term (<= 35 days) gain.

          Reply
          1. Ashish Gupta

            Terribly late to comment, but completely agree with Mr. Bharat Shah's point. If we agree that MF Excel tracker is for investor, then this computation is misleading. Tracking folio has no impact on fund's performance, and vice-versa. Fund's performance matters when selecting fund, and this post gives good idea not to consider dividend option to compare fund returns.

          2. pattu

            This is how dividends from mutual funds have to be treated for CAGR calculation as per SEBI guidelines as imo based on sound mathematical logic. If you dont like it, stay away from dividend option. The MF tracker has to account for as many investing options as possible and must be as technically correct as possible.
            If you can spot an error point it out. If I write a post without math, I will be happy to consider your opinion. For posts that are math-based, opinions sans math don't count for much.

        2. bharat shah

          thank you for comment . i think , it clears my point. the tracker is w.r.t. investor's investment ,so it should be considered like that. however i have no argument against shri pattu's view point.

          Reply
  3. Pattabiraman Murari

    Absolutely. That is the best, easiest and smartest way to do it. However if a dividend option is part of the folio, I will need to use the above approach to calculate XIRR by taking all transactions together.

    Reply
  4. Pattabiraman Murari

    Absolutely. That is the best, easiest and smartest way to do it. However if a dividend option is part of the folio, I will need to use the above approach to calculate XIRR by taking all transactions together.

    Reply
  5. IamNoSpecial

    Hello Raghu,

    I guess, you are suggesting too much of a correlation.

    By your approach, if I calculate returns of FIBC growth then I would automatically get returns of dividend fund? The dividend declared varies every year and correlating it with growth option would be more of a approximation or guess work kind of thing.

    Let us wait for Pattu's comments 🙂

    Reply
    1. pattu

      No Viren. Mr. Ramamurthy is correct. The growth option CAGR is always taken as equal to the dividend option when you want to track performance. If you want to track your folio, then you will the XIRR approach mentioned in the post.

      Reply
      1. Ramamurthy

        Pattu
        Can you please elaborate what you mean by the performance of your folio?
        Suppose you invest on 1.5.2014 Rs 10000 under growth option in Fund A.You are allotted a Folio.You again invest Rs 5000 under the same folio on 1.6.2014
        under the Dividend option.I presume according to you the best way to find out the total return under the Folio is by adopting the calculator you have suggested.
        Can you please confirm my presumption.
        Also in one of your replies to a query you have said dividends on equity funds are tax free.I dont think it is correct. The Fund House has to pay a Dividend Distribution Tax(nearly 30%).It is tax free in the hands of the recepeint of the dividend.Am I wrong?

        Reply
  6. IamNoSpecial

    Hello Raghu,

    I guess, you are suggesting too much of a correlation.

    By your approach, if I calculate returns of FIBC growth then I would automatically get returns of dividend fund? The dividend declared varies every year and correlating it with growth option would be more of a approximation or guess work kind of thing.

    Let us wait for Pattu's comments 🙂

    Reply
    1. pattu

      No Viren. Mr. Ramamurthy is correct. The growth option CAGR is always taken as equal to the dividend option when you want to track performance. If you want to track your folio, then you will the XIRR approach mentioned in the post.

      Reply
      1. Ramamurthy

        Pattu
        Can you please elaborate what you mean by the performance of your folio?
        Suppose you invest on 1.5.2014 Rs 10000 under growth option in Fund A.You are allotted a Folio.You again invest Rs 5000 under the same folio on 1.6.2014
        under the Dividend option.I presume according to you the best way to find out the total return under the Folio is by adopting the calculator you have suggested.
        Can you please confirm my presumption.
        Also in one of your replies to a query you have said dividends on equity funds are tax free.I dont think it is correct. The Fund House has to pay a Dividend Distribution Tax(nearly 30%).It is tax free in the hands of the recepeint of the dividend.Am I wrong?

        Reply
        1. pattu

          To find portfolio returns, you will need to combine all the transactions and use Excels XIRR function like the calculator does.

          Equity dividends are free from any tax. DDT applies only to debt fund dividends.

          Reply
  7. IamNoSpecial

    Oh. Thank you Ramamurthy and Pattu.
    However, would this hold good even if we consider debt or hybrid MFs? As the AMC along with dividend, would also have to cater to DDT?

    Reply
    1. pattu

      Yes it would hold good for all funds. The DDT is an action by the instrument (mandated by the govt). The dividend post DDT should be treated as reinvested at ex-dividend NAV for return calculation.

      Reply
  8. IamNoSpecial

    Oh. Thank you Ramamurthy and Pattu.
    However, would this hold good even if we consider debt or hybrid MFs? As the AMC along with dividend, would also have to cater to DDT?

    Reply
    1. pattu

      Yes it would hold good for all funds. The DDT is an action by the instrument (mandated by the govt). The dividend post DDT should be treated as reinvested at ex-dividend NAV for return calculation.

      Reply
  9. Amar

    Calculate returns(Dividend + Present Valuation) from Mutliple Amt SIP (Systematic Investment Plan)

    I am investing in few Mutual Fund for quite a time. I started investing from 2007 to 2012 through agent and then directly, My MF Investment is still active I want to know exact returns(Including Dividends received) i.e. Returns(Dividend + Present Valuation) . Also I started with Rs 1000/ month, then few months later I changed it to 1500/month again I changed to 2000/month and So on. So How do I calculate?

    Reply
  10. amit

    Lets say,NAV of growth plan purchasing cost 20 rs is now is 25 rs with 100 units,If i opt for long term investment(12 months plus),selling 10 units will fetch me,250 rs.paying STT etc at around 0.01% , my tax liability is 2.5 rs only with long term capital gain .But if MF company give 5 rs as dividend on it,100 units,DDT(dividend distribution tax)20% approx,i lost 20% of dividend as taxation.so 500-100=400 is left as my dividend.so opting Dividend option, my total value is 20*100 + 400=2400.while on growth plan,my value is 90*25+247.5=2497.5 rs.Hence,the MF/companies,make people fool, in name of dividends??
    Thus,i have received 97 rupees more,if i opted for growth plan??
    So advise me , if i have calculated it wrongly, somewhere??

    Reply
  11. RANJU

    What formulla should b used if we are reinvesting dividend on daily basis,xirr is not used for daily cash outflow..... Pls suggest

    Reply
  12. Mahesh

    Investment in a liquid fund with reinvestment option is subject to DDT. I want to know:
    1. Is NAV declared after deducting DDT.
    2. Is return indicated after taking into account DDT? e.g., retun indicated is 8% for 1 year. Is it net 8% or actual return is 8% minus DDT and thus less in that proportion say 5.6% for simplicity.
    Kindly clarify.
    Thanks

    Reply
    1. freefincal

      NAV is independent of DDT. So is return. Investor will have to calculated post-ddt return.

      Reply
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