Let’s say I borrow Rs10,000 from you today and promptly return Rs2,000 in a couple of days such that I now owe you Rs8,000. Will you consider your return on investment to be 20%? Obviously not. Only if I was to pay you the Rs2,000 and yet continue to owe Rs10,000 would you say the return is 20%. The fact that I paid back Rs2,000 such that I owed you that much lesser, it is return OF capital and not return ON capital. That’s as straight as it gets. However, many mutual fund investors mistake a return of capital for a return on capital.

Any dividend received from a mutual fund is essentially return of capital and not return on capital. The difference is moot, since an unclear understanding of this concept is being misused by many distributors to shove undeserving investments down an unsuspecting investor’s throat. This is especially true in the case of equity linked tax saving schemes (ELSS) where large dividends are doled out as March 31 approaches and investors are invited to invest based on the lure of a quick return on capital.

The pitch becomes even more bizarre when it comes to ELSS funds. Let’s say the NAV of an ELSS fund is Rs100. It whispers to the distributor (Sebi doesn’t allow a loud declaration of the impending dividend prior to five days of the record date) who in turn whispers to the investors that the scheme is set to announce a dividend of say 250% or Rs25 per unit.

The proposal is one that cannot be refused — 25% return from dividend (Rs25 divided by Rs100 per unit initially invested) plus 30% return due to the tax-saving, making a total of 55% return on investment. And this is just on the basic capital invested, if the scheme performs well, it will be additional icing on the lucrative cake. Now, let’s see why this boils down to downright cheating.

First, as explained earlier, the 25% return is not on capital but of capital. As soon as you receive the Rs25 as dividend, the NAV falls to Rs75. The 30% tax deduction is spread over three years of lock-in, so at best it is 10% per annum.