Changing the default option of dividend reinvestment in ELSS Mutual Funds..

Nice bit on default choices.

Mutual Funds offer ELSS funds (Equity Linked Savings Schemes) which are a tax saving fund and imposes a three year lock-in on investors. The idea is to promote equity investment and give both the fund (who gets tax sops) and investor (who gets locked in money) incentives for the same. The problem is dividends which are to be paid to investors.

Now it so happens that there are two choices for investors – payout or reinvestment of dividend. The default is the second one. So as always investors forget to tick their choice and reinvestment becomes the default. This leads to irritation for the investors:

With the tax-saving season under way, (MFs) have started aggressively promoting their equity-linked savings schemes (ELSS). These get a benefit under thelimit of Rs 1.5 lakh.   

However, investors are to no longer get the option. The Association of Mutual Funds in India (Amfi) has written a letter to asset management companies (AMCs) to stop offering this option.  The reason: Rising complaints during withdrawals. Fund houses already have Rs 36,257 crore in ELSS.

The letter says investors often forget to tick the ‘Dividend payout sub-option’, resulting in reinvestment of the dividend by default. Since the original amount invested qualifies for deduction under section 80C, even though the dividend reinvested does not qualify for any such deduction, the lock-in period rule is often misconstrued by investors, who expect to withdraw the entire balance of units (including dividend reinvested) at the time of redemption, after a three-year lock-in period of the original investment. Which they cannot do, due to lock-in of each transaction of dividend re-investment, leading to investor grievances,” says the letter.  MFs have been providing a growth option and dividend option under products, including a ‘Dividend reinvestment sub-option’, wherein the dividend amount reinvested is also subject to a lock-in of three years from the date of reinvestment.

🙂 Just as behavioral economics has told us how defaults matter. MFs chose the default to suit them as it redeployed the funds back in the fund. But for investors it was a bad deal.

The decision was arrived at after a meeting between the market regulator, the Securities and Exchange Board of India, and Amfi. The matter was also examined by the Committee on Operations and Compliance, which has recommended that the dividend reinvestment sub-option under ELSS products be withdrawn, to avoid any confusion among investors.

For existing investors, it means the dividend reinvestment option will be converted to dividend payout. An investor not wanting to receive the dividend can take the dividend transfer plan, whereby the dividend amount could be reinvested in any other open-ended scheme of the MF house. According to sources, some have already started implementing it.

The regulator could have instead asked to change the default setting to dividend payout . But it removed the reinvestment option completely to avoid any confusions. Shifting the dividends to other plans will lead to further problems of managing too many funds…

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