An often asked question when investing in a mutual fund is, “Should I choose the Growth or Dividend option?”
Well, let us understand these options:
- All profits made by the fund are ploughed back into the fund
- The Net Asset Value (NAV) appreciates over a period of time
- No dividend is paid out during the entire tenure of holding
- Income under this option is only receivable via sale of units
- Profits booked by the fund are distributed among unit holders as dividend
- The NAV of the scheme falls each time to the extent of dividend declared and paid
- Dividend or frequency is not guaranteed, and paid out periodically when decided by the fund
- Income under this option is receivable via dividends and sale of units
There is a third option – Dividend Re-investment, where the dividend is used to buy units in the same scheme. In January 2015, AMFI (Association of Mutual Funds in India) issued a circular asking funds to discontinue this option for tax-saving funds after complaints from investors as each reinvestment was further locked-in for 3 years. Some fund houses are phasing out this option across all schemes, and some are retaining it only for debt funds.
So how do you decide which of these options is the best for you? It depends – on what type of investor you are, as well as how this income is taxed.
– if you are someone who HAS a regular income, the Growth option makes more sense
– if you are someone who NEEDS a regular income, the Dividend option is more practical
- Under Growth option, gains on investment are made when units are sold. For equity funds, if units are held for less than a year, Short Term Capital Gains Tax (STCG) of 15% is levied on the profit. If sold after a year, they are exempt from Long Term Capital Gains Tax (LTCG)
For debt funds, profit is added to income and STCG is levied as per income tax slab if units are sold within three years. If sold after three years, LTCG @ 20% is levied, with indexation benefit (Indexation accounts for inflation during the investment period and adjusts the buying price)
- Under the Dividend option, all dividends are tax-free in the hands of the investor. However, for debt funds, the fund house has to pay a Dividend Distribution Tax (DDT) to the Government before distributing this dividend to investors
To summarise, a lot has to do with your cash flow requirements.
Can you invest money in a fund and watch it grow over time, reaping the benefits of compounding? Or do you need income at regular intervals irrespective of whether you’re a salaried / self-employed individual / retiree?
If you invest in a tax-saving mutual fund, are you comfortable with no income during the 3 year lock-in period? Or would you prefer to receive some dividend income during those years?
Do bear in mind that dividends are not guaranteed. If the mutual fund does not have enough surplus, it might not distribute dividends. Looking up the mutual fund’s past dividend payouts would provide some insight but is no indicator of future payouts.
Choose wisely, and happy investing 🙂
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