Understanding growth option and dividend option in Mutual funds

Written by: Kripananda Chidambaram

Understanding growth and dividend option in Mutual funds
I come across lot of mutual fund investors who are not yet familiar with growth option and dividend option.

Let us understand them.

We have noticed same mutual fund schemes having two options; growth and dividend option. Even their NAVs are different and in most cases dividend options are much lower than the growth option. So does it mean they are two different schemes? No the scheme invests in the same set of stocks or bonds but the nature of distribution of profit differs.

Growth Option:

Under growth option you will not receive any returns in the intermediary. You will not receive any payments in the form of interest, dividends, gains, bonus etc. You will get your returns only on selling the units. The returns will be the different of the selling price and the purchase price similar to gold investment. The NAV on the date of investment will be the cost price and the NAV of the sale date becomes the selling price. The difference is you return. For example you bought 100 units of a mutual fund scheme at an NAV of Rs 50 and you sold those units after 6 years when the NAV had reached Rs 120. So your returns will be Rs 7000. You will not get any payout in between.

Dividend option:

Under dividend option you will receive returns at periodic intervals. But the intervals are not certain and dividend amount payment is also not fixed. Under dividend option the NAV is not let to grow higher and whenever it reaches a certain level, the fund house pays out dividends. Assume you have invested in a fund at the NAV of Rs 14 and opted dividend option. The scheme performs and NAV reaches a level of Rs 16. The fund house may decide to pay out Rs 1.50 as dividend. So you receive Rs 1.50 and simultaneously the NAV will fall back to Rs 14.50.

Which option to choose?

This is quite straightforward. You may have to take 2 things into consideration while you decide; objective of your investment and tax considerations.

For equity mutual funds the best bet would be growth option. This is because you can make compounding work for you. If you receive regular dividends you may end up using that money for non-priority things. Wealth per se is created only if you let it compound. One instrument is giving you 15% returns per annum and the other is giving you 13% per annum and if the latter one is left to compound then it will create far more wealth than the one with is giving 15% returns.

That is why Gold or real estate is perceived to be big wealth creators.

For short-term(less than a year) investments in debt funds we recommend you to go to dividend option or dividend re-investment option, primarily on tax considerations. Though dividends are tax free at the hands of the investors, the fund has to pay tax (dividend distribution tax) of 12.5% before it pays you. In case of short term capital gains then you may have to pay at the marginal tax rate. So if your come under 30% tax bracket then you will end up paying lesser rate if you choose dividend option.

For long-term (more than 1 year) investments then you may opt for growth option as the capital gains tax in that case will be 10% without indexation or 20% with indexation.

Kripananda Chidambaram is Director at Fintotal

Read more about: mutual funds
Story first published: Friday, December 28, 2012, 9:24 [IST]
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