Mutual Funds - Growth Option vs Dividend Option
The issue of investing in mutual funds is a no brainer, particularly for those of you who want your economic objectives to be achieved. However, even after choosing the correct fund for you, evaluating your risk appetite, and making the optimum allocation of assets, the issue continues whether to invest in the growth option or the dividend option. The option selection is as essential as the mutual fund selection itself. Let's take a closer look at these alternatives.
All gains produced by the fund are planted back into the system in the growth option of a mutual fund scheme. The NAV improves the compounding of your principal over time. This is similar to the cumulative option in a fixed-deposit bank where interest is returned to the fixed-deposit account, which then witnesses an exponential growth over time. As an investor, to realize the growth in investment value, you will have to redeem the units in the fund.
This sort of investment is more suitable for long-term investment in equity mutual funds, as long-term capital gains (LTCG) are not taxed. Equity mutual funds are also susceptible to short-term risk, but typically produce excellent returns over the long term. This option benefits from the compounding power as it is not only the principal invested but also the notional profit. It's a good option for those who don't have to rely on their investment for their living on monthly revenue.
Moreover, given that the fund is not distributing any dividends, the NAV exceeds the dividend option of the same fund. However, this difference is due only to dividend payments, not to a significant difference in fund results.
The profits made by the fund are distributed from time to time to unit shareholders in the dividend option of a mutual fund scheme. If you expect periodic income from your investment, and not redeem one of these units, then you should choose the dividend option.
As an investor, you should note that the fund's net asset value (NAV) always reduces by the dividend amount payable to investors and any repurchase following the ex-dividend payout date is made on an ex-dividend NAV.
This option is perfect for short-term, particularly debt investments. Debt mutual funds with dividend options are a great choice for senior citizens who need constant income flows, not just appreciation of assets.
This option gives the investor the advantage of moderate capital gains and dividend returns over the holding period. It should be noted that compounding power is not as effective owing to the payouts as compared with the growth option. Investors who do not rely on dividend income will also experience the risk of reinvestment, i.e. reinvesting the money gained through dividend into an asset class that provides excellent returns.
Difference between Growth Fund and Dividend Fund
To demonstrate the distinction between the two options, let us take an example:
- Assume you've invested Rs.1000 in a fund's growth and dividend option respectively with 250 units each. The NAVs for both growth and dividend options are each at Rs.50.
- Say the fund is declaring a dividend of 15 percent. The dividend payout will be Rs.6 per unit held on a face value of Rs.40 per unit held.
- Your dividend investment will generate an Rs.1500 (Rs.6 x 250 units) dividend. The dividend option NAV is now going to drop to Rs.44 (NAV Rs.50 – Dividend Rs.6).
- The investment in the growth option will produce Rs.12,500 (NAV Rs.50 x 250 units) while the dividend option will offer you Rs.11,000 (NAV Rs.44 x 250 units) if you now redeem all your units in both options.
- However, as you have already received an Rs.1500 dividend, the total yield from both investments is the same (Rs.12,500 in Growth Option & Rs.11,000 through unit redemption + Rs.1500 as dividends in Dividend Option).
Dividend or Growth - What to choose
The decision between these two options should be guided mainly by the requirements of your cash flow. If you do not need regular liquidity, you can select the growth option. The growth option's returns will be expressed in the NAV motion of the scheme.
On the contrary, choose the dividend option if you need frequent money flows from your investments. Please note, however, that dividend payment is not guaranteed and there may be no dividends if there are no surpluses generated by the fund. As far as tax implications are concerned, taxation on growth funds is easy since only capital gains are calculated and long-term capital gains are not taxed on equity funds, while short-term capital gains are taxed at 15%.
Short-term capital gains are taxed at 30% for debt funds in the growth option, whereas long-term capital gains are taxed at 10% without indexation or 20% with indexation.
In the case of dividend options, however, the dividend is tax-free in the investor's hands, but before giving the dividend, the fund will have to pay dividend distribution tax (DDT).
To summarize in short,
- Growth option is not going to pay out any provisional dividends, and it's just giving capital gains.
- Growth is best for long-term investment and equity investment.
- Dividend option will provide uneven payouts, which are tax-free in the investor's hands.
- For short-term debt funds, dividend options are best.
As always, we advise you to take a financial advisor's expert advice to assist you to identify an option that best suits your financial requirements and tax status.