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Concepts & Tutorials

Mutual Funds: Dividend option or Growth option

Most mutual funds have multiple options for investment, for the same scheme:

1) Growth option
2) Dividend option
(with either automatic reinvestment or as a payout)

The concept behind Dividend option is that the mutual fund gives you “cash” regularly. and this can be either paid to you or reinvested in the fund (more units are purchased on the day of the dividend disbursement, at the NAV of that day). Note here that dividends are paid out of the assets of the fund, therefore the Dividend option’s NAV will go down when dividend is paid.

Dividend payout is usually taken by people who want some cash return on their investments. In a way, this supplements their income, and also ensures some level of “profit booking” – that profits will be paid out as dividends so you keep your exposure limited.

The dividend re-investment and growth options are similar, in the sense that your dividend adds on to your investment and compounds itself. So why two different options?

That’s based on tax history. Earlier, your capital gains were taxed at 20% (long term) and 30%(short term). Dividends were taxed at 10% and later, not taxed at all. Growth option funds only had capital gains (since there was no dividend) and when you wanted to exit you would pay a HIGHER amount of tax. Dividend reinvestment ensured that your dividends paid lesser tax and the re-investment, being usually at a higher NAV since the fund is growing, will attract less capital gains tax.

But now the equation has changed. Currently, Dividends are not taxed in your hands. (and equity mutual funds aren’t charged a dividend distribution tax) Also, with the Securities Transaction Tax regime, you pay a 0.25% STT on the sale of your fund units, and therefore the law says that short term capital gains tax is 10% and long term capital gains are not taxed!

So what’s the difference now? One factor to consider is that some funds must pay dividend distribution tax at 12.24% – this does not apply to equity funds. Obviously this affects the dividend options but not growth options of funds.

Further, there’s capital gains. Let’s say you invested in a fund 5 years ago, in “dividend reinvestment” and now you want money urgently. Some of the units you got as part of the dividend reinvestment were perhaps given to you in the last one year; selling those will mean a short term capital gains tax of 10%! If you had chosen the growth option, you would pay no capital gains tax (as all gains are long term = greater than one year of holding).

Always choose the Growth option. If you need cash regularly, choose the Dividend payout option. Don’t really bother with Dividend reinvestment (unless tax laws change).

Disclosure: I have, unfortunately, invested in the “dividend reinvestment” option myself also. I will slowly change over and further investments will go into growth options only.

See the video by MarketVision:

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  • Mohan C Nair says:

    >Hi Deepak,

    I find the dividend re-investment option quite amusing. The fact is that when a fund performs well it declares dividends. This ensures that some portion of the fund’s corpus is realised for disbursement of the dividend without reducing the number of units. Agreed, this is fantastic. What is more fantastic to me is buying more units of the same fund since it is doing well. The dividend re-investment option provides such an oppurtunity without the necessity of shelling out cash, with the divident payout funding the purchase of addtional units. This way you have increased the number of units in a performing fund. This is a kind of hybrid option that increased the NAV as well as the units. Please let me know if my views are flawed.

  • Deepak Shenoy says:

    >Mohan,

    1) Dividends are not given necessarily when the fund performs. Unlike company law where companies can only declare dividend out of profits, MFs have no such restriction (some MFs even declare dividend when they have lost money!)

    2) Growth option is exactly the same as MFs, except the number of units stays the same and the NAV goes MUCH higher. If you take growht option of an equity mutual fund (which has no dividend distribution tax) and compare it with the dividend reinvestment option of that same scheme, the value after x years will be exactly the same. One has more units and lower nav, one has less units but higher NAV…

    Cheers,
    Deepak

  • Mohan C Nair says:

    >Hello Deepak,

    Thanks for clearing my mind. Will apply thought next time i suggest anybody on this. BTW one of my friend says that the NAV of the dividend option of a Fund can go higher than the growth option after sometime of giving dividends. Is this true? I understand if the portfolio holdings among the Growth and Divident options are different in terms of companies and percentages within the objectives of the fund. But otherwise????

    Thanks

  • Deepak Shenoy says:

    >Mohan, I have never seen the NAV of a dividend option of a fund go higher than the growth option. Portfolio holding wise, they could be different I guess, though not by much I would think.

    Otherwise there’s no fathomable reason for a dividend option to go higher. Do you have any examples?

  • Mohan C Nair says:

    >No I dont have any clear examples as such as this was told by one my friend. He is also into investing a lot. But for example although the portfolio holdings in Sundaram Capex Oppurtunites D and G are same, the propotions do differ. This in my knowledge will affect the performances of the schemes. So there is no point in treating this as the same scheme with just the G and D Options.

  • Anonymous says:

    >Hi Deepak

    Nice reading your post.Plain english lot of gyan.Keep up good work pal.

    Why dont u throw some light on F&O ?

    Not much useful info available on net as of now.

    Karthi

  • Saif says:

    >Hey Deepak,
    This dividend reinvestment and growth was a question that was niggling since long in my Mind.
    Thanks for posting it here!
    Saif

  • Neel says:

    >Hi Deepak,
    I had this doubt since long time. Thanks for the “Gyan” with a historical perspective.

    ~Neel

  • ganeshadhruth says:

    >I have a comparison of Growth and Div Reinvestment options. That clearly shows Div reinvestment option is better. My comparison is available at http://moneyindia.wordpress.com What are your views?

  • Deepak Shenoy says:

    >Ganesh, In your last line you’ve assumed that 18.78 is the NAV of the Dividend option – it is not, it comes down to Rs. 16.28 post dividend. Which means the net return is Rs. 95,833 as against a growth option of 94,611.

    Still, that’s a Rs. 1200 difference. Perhaps attributable to higher management fees (?) but there’s something fishy here all right. The only other thing I can think of is that you will get short term capital gains tax on profits of units bought through the reinvestment – but it seems that this time there has been only losses in the past year (notionally).

    A little weird there. Worth asking them the question though.

  • Anonymous says:

    >Hello Deepak,
    I have one question. In case of share listed on Exchange, dividend are payed on face value and not on Market value. In case of Mutual fund NAV indicates market value of assets in that fund. So when MF gives out dividend say 10% then is it on NAV or NAV of fund at time of NFO which is usually 10 .

    Thanks in advance.

  • Deepak Shenoy says:

    >anon: mutual funds are also expressed as a % of face value, not NAV. THe face values of most funds are Rs. 10.

  • Anonymous says:

    >Excellent post Deepak, it cleared my questions on dividend re-investment

  • jayant says:

    >I have a question! does dividend & growt option have similar portfolios:

  • Kitt says:

    >I have invested in many Dividend plan and i do not require any income and now would like to move to the growth plan.

    Will doing this cause a reduction in value of my investments ??

    Thanks