What is the difference between “Growth and Dividend option in Mutual Funds”? Why some people prefer growth option, while other prefers dividend option, in mutual funds?
You are often seeing the advertisements from Mutual Fund companies regarding the announcement of dividends. Agents will use this as an opportunity to sell such Funds at that time showing dividend as an extra payout. What is the truth in Mutual Fund dividends? Is it really attractive?
Before answering this question, let us study the Growth and Dividend Options in Mutual Funds.
Growth Option in Mutual Funds
While investing in a Mutual Fund, if you opt for the Growth Option, you are not eligible for any dividend. But the gains made by the Fund will be reflected in the value of your investment by way of higher NAV. This is the reason why NAV of the Growth Plan is higher than the Dividend Option. You can enjoy such gains only when you sell the Fund.
Dividend Option in Mutual Funds
In this option, you will be paid dividend out of the profits made by the Fund. But the declaration of dividend is at the discretion of the Fund House and is not guaranteed. Dividends are often declared as a percentage on the face value of the units. Imagine the current NAV of a Fund is 20 and it declares a 20% dividend today. It means an amount of Rs. 2/- per unit will be paid to you. (20% of the Face Value Rs. 10/-). But after the payout of this dividend, the NAV of the Fund will fall to Rs. 18/-, which is called the ex-dividend NAV. So, in this case, you are not getting anything extra compared to the investor, who has opted for the Growth Option.
The dividend in Mutual Fund is not an extra benefit paid. The amount paid as dividend is reduced from the NAV immediately. So, it is nothing but, returning a part of your own investment. You will feel happy, because you are getting that amount in hand, but to that extent, your savings is reduced.
Growth and Dividend Option in Mutual Funds – How to Choose?
You should select the option, as per your financial goals and in line with your cash flow planning. For long-term goals like your retirement, child education and their marriage, opt for Growth Option to get the benefit of compounding. If you opt for Dividend Option, the dividends paid will reduce the NAV and you may not get the desired amount for the long-term goal.
But, if you are looking for some cash flow from your investments, then you can opt for Dividend Option. But please note, that there is no fixed frequency of payments in Dividend Option. The Fund House will decide the amount and the date of dividend.
Growth and Dividend Option in Mutual Fund – Taxation
The taxation rules are different for Growth and Dividend Options.
Equity Mutual Funds
As per the current tax laws, Long-term Capital Gains from Equity Mutual Funds are tax- free. The gains are treated as long-term, if you have invested there for more than 1 year. It is better to opt for Growth Option and get the benefit of tax-free capital gain, if your investment horizon is more than 1 year.
But, the Short-term Capital Gains will be taxed at 15%, if you are selling the Equity Mutual Funds within 1 year. So, in this case, it is better to go for a Dividend Option, because the dividends are tax-free. There is no dividend distribution tax in Equity Mutual Funds.
But investing in Equity Mutual Funds for a 1 year horizon is highly risky and it’s better to avoid.
Debt Mutual Funds
Dividends received by you from Debt Mutual Funds are tax-free, but there is dividend distribution tax (DDT), paid by the Fund House before declaring the dividend. The rate of DDT is 25%. There is a surcharge of 10% and Education Cess of 3% on it, which makes an effective tax rate of 28.325%.
In Growth Option, the taxation is different. If you redeem your investment after 1 year, the gains will be treated as long-term and will be taxed at 10% without indexation or at 20% with indexation. Indexation will help you to offset the effect of inflation and the tax liability will be reduced, in periods of high inflation. Growth Option will be better if the duration of investment is more than 1 year.
But if you sell your Debt Mutual Funds within 1 year, the gains made will be treated as Short-term Capital Gains and you have to pay tax on it as per your Income Tax slab. If you are in 30% tax slab, you have to pay 30% tax on such gains.
Growth and Dividend Option in Mutual Funds – Which is better?
By now, you are clear about the difference between the two Options. Now which Option is better?
Since Mutual Fund investments are for long-term, it is better to opt for the Growth Option both in Equity and Debt Mutual Funds. Dividends paid by Mutual Funds are not like Dividends paid in Shares. Mutual Fund Dividend is nothing but partial withdrawal of your money, at the discretion of the Fund House!