The following are the choices available to an investor while investing in mutual funds:
Growth option of mutual fund is one in which any return or profits earned by the mutual fund scheme are invested back into it.
Overview of Growth option –
- The profits are not paid out in between but keep on accumulating in the scheme.
- Profits are reflected in the NAV. This results in an increase in the net asset value (NAV) of the scheme over time. When the scheme makes profit, the NAV rises and in case of a loss, it goes down.
- Investors are not paid any dividends in growth option.
Dividend option of mutual fund offers regular income for the investors by way of repaying a part of the investment each year. The repaid amount is known as dividend which is declared on a per unit basis for the mutual fund.
Overview of Dividend option –
- They are distributed to the investors/shareholders from time to time.
- Dividendscan be received as a source of income or they can be used to buy more shares of the mutual fund.
- The dividend is paid from the NAV of the unit.
- Dividends are declared only as and when the mutual fund scheme makes a profit and thus the amount and frequency of dividends are never guaranteed.
- A dividend is not over and above the invested money – it is a part of the investment made by the investor.
The dividend options are of two types –
- Dividend payout option
- Dividend re-investment option
In case of the dividend payout option, a part of the profits of mutual fund scheme are issued as dividends to unit holders, which are transferred to their bank accounts. Profits or dividends are thus not reinvested by the fund. The NAV of the fund falls to the extent of dividend paid out.
Under the dividend reinvestment option, the dividend is declared, but not physically paid out. The dividend is used to purchase new units of the same mutual fund and reinvested back into the scheme leading to an increase in the number of units of the fund over time. The new units of the scheme are purchased at the prevailing NAV after dividend is declared, and added to the folio.
Dividend Payout or Dividend Re-investment or Growth: What should one opt for?
Wealth creation in the long run
One can invest in growth or dividend re-investment options for long term wealth creation.
In a dividend plan, each time the dividend is declared, a dividend is paid out of the wealth accumulated in mutual funds and this reduces one’s long term wealth. Unless these dividends can be reinvested back at the rate of return that the fund is earning, the growth option will always be a better option when compared to dividend option for wealth creation over the long run.
An equity fund had an NAV of Rs.10 when the fund was started in 2012 . At the end of five years, the NAV of the growth option was Rs. 46 and that of the dividend option was Rs. 20. In case of dividend option, the remaining Rs.26 (Rs 46 minus Rs 20) had been paid back by the fund as dividends.
The tax savings angle
Taxation structure must be taken into account while choosing the growth option or the dividend option.
Taxation on growth funds depends on the type of fund. In case of equity fund any profit on sale of fund units within one year of holding would result in short term capital gain tax which is taxed at 10%. Any profit earned by sale of mutual fund units after one year of holding is called long term capital gain and do not attract tax.
The dividend option might be a good investment if a person intends to save tax, since the dividends are tax free in the hands of the unit holder.
However equity mutual funds provide attractive returns if held for a period of over five years.
In case of dividend re-investment option, it is quite similar to growth fund. The new units are purchased from the declared dividend income instead of being distributed to the investor. The most advantageous part about dividend re-investment scheme is that it is best as regards to tax saving.
Saving for specific life goals
The best way to handle the mutual fund portfolio is to earmark specific portfolios for specific needs. A growth option is usually suitable if the objective is to create a corpus for a few goals – long term or short term.
For example, one needs to plan for paying the amount for a new car or for taking a foreign vacation in the short term. One needs to plan for child’s education/marriage, retirement etc. To accumulate money for such needs it is always advisable to opt for a growth option. Give that Growth option follows the theory of compounding, the more the investment, the more the earnings. The more one reinvests what is earned, the more wealth created.
The need for regular income
A Dividend payout option is good if one is looking for regular income. However, if the amount of investment is too small like Rs 8,000 the amount of dividend received will be negligible. The invested amount should be sizeable enough to get enough income from investments under a dividend option.
Dividends on equity funds are not assured., dividends on debt funds are more regular and predictable.
Debalina Roy Chowdhury