Misleading Information 3~ Dividend Paying Unit Trust Funds are Good Funds

Dividend paying unit trust funds are good funds, that’s why they worth our investment priorities.

This misleading concept probably comes from dividend stock concept. There are investors prone to look highly on those dividend paying stocks. Their concept is these dividend paying companies are making money, that’s why they are able to pay investors a share of the profit. While this is true for stock, however, it is entirely different when it comes to unit trust fund house.

The increases of asset value (or NAV) of a fund house can come from two sources. First, it comes from the profit from investment. Secondly, it can come from direct investment of new investors. For stock, new investment can cause price of the stock to rise in the open market due to the law of demand and supply.  However for unit trust, new investment does not cause any effect on the price of the unit trust.These new investments will only cause the total pool of cash money (total capital) to swell up. But the value will also be diluted due to the new issuance of shares to these new investors.That’s the reason why NAV remains the same before and after new investments come in. (Please see also for detail discussion How NAV of a fund being determined)

Manipulation of Dividend

Furthermore, the fund house, however, can use this “extra” cash “collected” (possibly due to heavy sales campaign going on) to pay back to existing investors and declare as dividend. This will lead to investors mistakenly feel that this fund is making profit, that’s why it can declare dividend to investors, where in fact, this might not be necessary true.

If you have been investing with Unit trust long enough, you might have also discovered some poor performing Funds, meaning their NAV were declining over a year or so, can still declare dividend.   This is, partly, to create a smoke screen or drawing investor’s attention away from their poor performances. Secondly, it is also to satisfy the unrealistic demand of its investors who might not have a proper education how dividend works for their fund NAV.

Dividend and Investors’ Benefit

Another very important aspect is that, whenever a fund declares dividend distribution, investors do not really benefit anything at all. If investors are cautious and watchful enough, upon the ex-date (the date determining qualified recipients of dividend), the price of their fund drops in a rate exactly in proportion to the rate of dividend declared which would be paid out to investors later after roughly a month. This means investor’s investment would have lost that amount according to the dividend value temporary.

After about a month, the dividend amount will be added as free units to the qualified investors’ accounts (if they choose reinvestment scheme). After which, everything falls back as usual as before. Consequently, investor does not benefit anything aside from having the number of units being added~ the number of unit becomes larger. But the total value of his investment remains the same, except slightly higher than a month ago because price would have gone up after that interval. This means, in reality, even if there were no dividend declared, your total value of investment would have gone up with the same value after a month as well. (For further discussion, please refer to article on “How do dividend affects NAV of mutual funds” and also “Two Big Mistakes Investors often make in Unit Trust Investment.”)

In unit trust investment, investor makes money based on the increase in unit value (or price) after his initial price when he first bought in, not according to the number of unit one holds in his account.  It‘s all about the difference between the entry price and the exit price. For example, if someone holds 500 units recorded in his investment account and the unit price is RM 1.00.  It will be meaningless if his units increase to 1,000 where in fact the unit price is dropped only to 0.50 per unit. The value of both scenarios is also RM 500.00. There is no increase in investment value at all.

Unfortunately many fund houses use this tactic to do promotion in order to attract new investors. They are taking advantage over the lack of proper financial education of the public at large.  Therefore it is so important to have a proper investment education for the public. This is also the very purpose of this web blog intended to be.

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