Dividend vs Growth options for mutual fund investment: What can make you rich fast?

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November 07, 2021 12:03 PM

There are two broad types of options for mutual fund investors - Dividend and Growth. Experts say that investors should choose either option basis their investment objective. Tax implications should also be factored in before selecting any of the two options.

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There are two broad types of options for mutual fund investors – Dividend and Growth. Experts say that investors should choose either option basis their investment objective. Tax implications should also be factored in before selecting any of the two options. The basic difference between dividend and growth options is that the profits made by the mutual fund is paid back to investors after certain intervals in the previous option and re-invested in the scheme in the latter option.

Under the dividend option, profits made by the mutual fund scheme are paid out to investors at certain intervals like annual, daily, monthly, quarterly etc. In the growth option, profits made by the scheme are re-invested in the scheme instead of being paid out to investors.

However, the fund’s portfolio remains the same in both options

“The underlying portfolio of both dividend and growth options are exactly the same. When a fund manager books profit the impact is the same in both dividend and growth options. The only difference is that profits are reinvested in growth option and distributed in dividend option,” Dr Ravi Singh, Head of Research and Vice President of ShareIndia, told FE Online.

According to Vinit Khandare, CEO and Founder of MyFundBazaar, the NAV will be higher in growth option as the re-invested profits may earn profits. Also, the total return is higher in the growth option.

“In the dividend option profits booked by fund manager are distributed to investors. The dividends paid are deducted from the NAV making ex-dividend NAV lower. While the total returns will be lower compared to growth option in the long-term due to periodic payouts, taxation is as per the income tax slab rate of the investor,” Khandare told FE Online.

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“In the growth option profits booked by the fund manager are re-invested in the scheme. Unlike the Dividend Option, the NAV will be higher because profits re-invested may earn profits. Also, the total returns will usually be higher compared to dividend option over sufficiently long investment horizon,” he added.

Anurag Garg, Founder and CEO of Nivesh.com, said that under the growth option, you may earn profits on profit and thereby benefit from compounding since the profits are re-invested in the scheme.

Who should opt Growth option?

Experts suggest that investors who do not need regular cash-flows may invest in growth options. NAV in growth options will be higher since profits are reinvested in the scheme, investors may earn profits on profit and thereby benefit from compounding. Total returns will usually be higher compared to dividend options over sufficiently long investment horizons.

Garg suggested growth options for those investors who have a long investment horizon and risk-taking ability. This option can also suit those investors who want to create wealth. “Younger investors will be more suited to this option, those who are single or young couples with small children,” he said.

Khandare said the growth option may be better for those under the 10% tax bracket as there is no Dividend Distribution Tax. The NAV of growth option will always be higher than the dividend option because the re-invested in the growth option may grow in value over time.

Who should opt Dividend option?

Experts say investors who require regular cash-flows from their investment may invest in dividend options. However, the post-dividend NAV may be lower in the dividend option.

“Dividends paid are deducted from the NAV. So ex-dividend NAV is lower. That’s why total returns will be lower compared to growth options in the long term due to periodic payouts,” said Dr Singh.

According to Garg, the dividend option would be better for those investors who are retired and not earning anymore. It would also be suitable for those who do not have a stable income stream.

Khandare suggested that the dividend option may suit individuals falling in the 20-30% income bracket. “The Dividend Option is better if an individual falls under higher income bracket (20-30% & above) as the the Dividend Distribution Tax is lower. Debt Schemes if held for short term, less than a year, then capital gains tax will be added to income and taxed according to the slab,” he said.

“In other words, since the dividends have become fully taxable in the hands of taxpayers, it would make sense for you to opt for dividend option in case your total taxable income does not exceed Rs 5 lakh for which you can claim rebate under Section 87A effectively making the dividends tax-free in your hands,” he added.

Which option can give more returns in the long run?

“Growth option, since the returns are reinvested and returns are earned on the reinvested amount allowing for compounded returns to be achieved. The investor gets their invested amount plus compounded returns. In the dividend option since payouts are made regularly at the end the final amount left is the principal invested,” said Garg.

“Dividend option can be futile for the investors who don’t need regular income as the money could remain idle in the bank account. Through growth option, investor need not worry about reinvesting the dividend received, it gets reinvested automatically,” he added.

However, experts say that the selection of either option is a matter of individual choice and needs. The final return may also depend on whether you are investing in equity or debt funds.

Tax implications

According to Singh, dividend option is taxed as per the income slab rates of the investor. However, tax implications for growth option begin on redeeming the fund.

“Income Tax Act provides for mandatory deduction of TDS at 10% from dividend income in case of Resident Individual. However, no TDS is deducted if aggregate dividend distributed or likely to be distributed during the financial year to an individual unit holder does not exceed Rs 5,000. In the absence of a Permanent Account Number, the TDS rate would be 20%,” Singh said.

“There is no incidence of taxation in growth options unless you redeem. In equity funds, short term capital gains (held for less than 12 months) are taxed at 15% and long term capital gains (held for more than 12 months) of up to Rs 1 lakh are tax exempt and thereafter, taxed at 10%. In debt funds, short term capital gains (held for less than 36 months) are taxed as per the income tax slab of the investor and the long term capital gains (held for more than 36 months) are taxed at 20% after allowing indexation benefits,” he added.

(Mutual Fund investments are subject to market risks. Views/Suggestions expressed above are those of the respective commentators. Please consult you financial advisor before making any investment decision.)

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