Should I go for growth option or take out the dividends in my fund?” is a question frequently asked by many of you, when venturing into mutual fund investments. Before I move on to discussing what suits you best, let me get down to some basic facts.
The difference
The growth option simply implies that the profits you make stay reinvested. In other words, the profits, along with your capital, are invested in stocks/debt to earn you more money.
Dividend payout implies that a part of such profits (an amount that the fund decides to give out) is stripped from your Net Asset Value (NAV) and given to you. That means, a part of the fund’s profits are given in cash. Hence, your NAV falls to the extent of dividends. This is why the NAV of growth and dividend option are not the same.
In dividend reinvestment option too, profits are stripped. But instead of giving them as cash, they are allotted to you as units at the prevailing NAV. Hence, indirectly, by adding more units, you simply stay invested in the fund. Conceptually, the dividend reinvestment option is the same as growth option for all equity funds.
Two key factors will determine what is appropriate option is for you:
1. Cash requirement and time frame
2. Tax efficiency.
Most people base their decisions on tax efficiency. While it is a key deciding criteria, let us also look at how other factors too, will play a role in choosing between dividend and growth.
Equity Funds
Let’s take on the easy one first. Equity funds are meant for the long term. Your reason for choosing an equity fund must be to build wealth towards some goal which is perhaps at least few years away.
That simply means you should stay invested in the fund and not take the cash out (unless you will invest the dividends back diligently) to help compounding work for you. Since, long-term capital gains are free of tax, the solution here is simple: As a general principle, go for growth or dividend reinvestment option in equity funds.
But there are exceptions: One, in case of theme funds or sector funds that you hold tactically, it makes sense to either opt for dividend payout or book profits as the fortunes of themes can take a turn after one good cycle. Two, in case of Equity Linked Saving Scheme (Tax saving schemes), avoid dividend reinvestment as every reinvested unit will be subject to a three-year lock in. Prefer growth, Three, if you are generally risk averse and prefer to take your money out to invest in some debt option, then you should consider payout or set triggers to book profits.
Debt Funds
This category gets a bit tricky because the dividend suffers Dividend Distribution Tax (DDT). DDT is nothing but the tax on the dividend paid out in debt and debt oriented funds and gold funds. DDT is not applicable for equity funds.
Let us suppose a fund declares Rs 10 as dividend. A DDT of 28.33% is Rs 2.833. Now while you will get Rs 10 in your hands, Rs 2.833 will be further reduced from your NAV (your NAV after dividend will be pre-dividend NAV minus dividend minus DDT).
So if your income is subject to 10 or 20% tax bracket, it is prudent to opt for the growth option, Those in the 30% tax bracket, can go for dividend payout, only if you intend to hold the fund for less than a year. But if you can park your money for more than a year and have no immediate cash flow requirements, opt for growth option right when you invest. Remember, switching between options will also unnecessarily entail capital gains tax if you have profits. Hence, get your investment time frame right when you start your investment.
So the next time you feel confused about which option to choose while investing in mutual funds, hope this information helps you in making a carefully thought-out decision.
