Investing in mutual funds has come a long way since its early days. With other asset classes such as real estate in a cyclical downturn and fixed income interest rates on the downward trajectory, mutual funds as an investment option is gaining traction. Both one-time lumpsum investment and regular disciplined systematic investment through SIP are finding more takers as people invest money into this financial instrument.
Growth or dividend
While investing in MFs, an investor has to choose either growth option or dividend payout option. Usually, not much thought is given or considered when one ticks this option in the investment form, but one needs to understand the consequences of each option. If you need a constant cashflow at a regular / intermittent time horizon, you should opt for a dividend option. The dividend, if received from an equity mutual fund, is tax free and it contributes to your income and cashflow needs.
In a growth option, the fund corpus grows along the growth of the mutual fund market value, which is measured in Net Asset Value (NAV). No outflows in terms of dividend is distributed and the investor can enjoy the fruits through capital appreciation. As of today, the proceeds from redemption post a one-year investment period, in an equity mutual fund, is free from capital gains tax.
In a dividend payout option, the investor enjoys both dividend payout and capital appreciation. Over the last 20 years of the investing journey of the mutual fund industry, it has been observed that generally, the annualised return of the growth option in an equity mutual fund is higher than the option of the dividend payout.
Why is this so? Dividends are distributed from the profit generated from the scheme. So any distribution of dividend from the scheme will only go to reduce the NAV of the scheme. Again, as the dividends are looked upon as a cashflow need, the dividend so declared will reduce the corpus and the annualised growth over the investing period. So you need to consider this option very meaningfully, while investing in the schemes, more so when the investing time period is multi-period or perpetual or in excess of three years.
Distributing dividends does not mean that the fund/scheme is performing well. One should not confuse mutual fund dividend distribution with the dividends distributed by listed companies. Dividend payouts by a mutual fund house results in an investor getting back part of his capital back. It creates a positive perception of the scheme with the investor.
Again, when the market outlook is bearish or the fund manager has no opportunities in the market, distribution of dividend is a good option. This has been noticed when certain fund houses distributed dividends regularly during the period 2015-16 citing lack of investment opportunities. Also, in an overheated market, to reduce the impact of downward movement, the fund manager prefers to distribute the profits as dividend.
If you are looking at creating long-term wealth and have an investment time horizon in excess of three years, growth option can create more wealth as compared to the dividend payout option. If you are looking for both income and capital appreciation, opt for dividend payout. While investing, know why you choosing a particular option. Your wants and needs are unique to you. Use the investment products and their options based on your requirements.
The writer is managing partner, BellWether Advisors LLP