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Options for retail investors in mutual funds

Last Updated 28 May 2017, 18:28 IST

As an investor, when investing in mutual funds, you must have been confused while deciding between Growth and Dividend options. You must have asked this question yourself — which option is better? Growth or Dividend? Do remember that the option you tick in the box will decide your future cash flows, income accruals, taxability, the number and value of units.

Also do bear in mind that whatever option you choose, the returns are the same for both the options as the scheme that you have invested in share the same basket of securities.

For the uninitiated, here’s the low-down on the various options mutual funds offer:

Growth option
Under this option as the name suggests, the NAV grows along with the appreciation in the portfolio value. You don’t receive any payouts whenever the fund declares dividends. If you need money you have to redeem either part or all units. This is also the default option. This option is ideal for those who don’t depend on regular income streams but instead want to create a corpus for a long-term goal like a retirement fund.

Dividend option
The profit earned by the mutual fund schemes from the investments in the portfolio is paid out from time to time in the form of dividends. This option is recommended for those investors looking for regular income from their investments. The Net Asset Value of the scheme falls to the extent of dividends declared, as the profits are paid to investors. So as more dividends are paid out from time to time, the difference in the NAV between the two options will keep increasing.

The dividend payout option seems attractive for investors wanting a regular income. But bear in mind that dividend declaration is a function of distributable surplus and there is no guarantee that you will get dividends regularly. If there is no surplus to distribute, dividend will not be declared by the fund. Therefore, if you are looking for regular income, you need to opt for SWP( Systematic Withdrawal plan). However, redemption of units under an SWP may have STT implication in equity schemes and capital gains tax implication in both equity and debt schemes.

Receiving dividends from time to time also means you are recovering your initial investment. You also don’t have to pay any tax on the dividends you are receiving. While the dividends you receive is tax-free in your hands, the scheme or the fund house has to pay Dividend Distribution tax to the government in respect of dividends distributed on units of debt schemes.

Dividends declared under a debt scheme are subject to dividend distribution tax
Dividend in a debt scheme attract dividend distribution tax, which reduces the NAV. Thus, the investor is effectively bearing the cost of the dividend distribution tax, although it might be paid by the scheme to income tax authorities. This cost might be fine for an investor in the high tax bracket, because the impact of the distribution tax could be lower than his marginal rate of taxation (which comes into play for taxation, if the investment is held for less than a year).

But for a senior citizen with no taxable income, or whose marginal rate of taxation is lower, it is meaningless to bear the cost of distribution tax. Thus, for such investors, dividend option may not be preferable though dividends are precisely the reason they invest in the first place!

Dividend reinvestment option
Under the dividend option, one has another option called dividend reinvestment option. It is similar to growth option in terms of value. The only difference is whenever the dividend is declared, additional units are allotted and added to your folio. It increases the number of units one holds for the same cost price.
While in a dividend payout option, the investor receives the dividend in his bank account and the NAV goes down to reflect the dividend paid out, it does not change the number of units held by the investor.

So which option is better? That depends on your need for a regular income and the objective of your investment.

(The writer is a former banker. He is currently teaching at Manipal Academy of Banking, Bengaluru)

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(Published 28 May 2017, 16:13 IST)

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