When selecting mutual funds for your portfolio, you could face multiple choices. Among the more complex decisions is to choose between a fund with a growth option or a dividend option. While each type of fund has its own merits and demerits, deciding the better fit depends on your individual circumstances as an investor.
This article helps you understand dividend and growth options under mutual funds and which of them can be suitable for you.
Mutual funds with dividend option
In the case of dividend option, profits made by the mutual fund scheme are not reinvested in the scheme. Instead, they are distributed among the investors by way of dividends on a quarterly, semi-annually or annually basis. However, the fund manager declares dividend only when the scheme generates enough profits. Hence, the amount and frequency of dividend pay-out are not fixed.
In addition, dividends are paid by redeeming equivalent units of the mutual fund scheme. For example, you invest Rs. 100 in an equity fund. The NAV of mutual funds (Net Asset Value) increases to Rs. 150 and the fund manager declares a dividend of Rs. 30. After paying the dividend, the NAV of the fund stands at Rs. 120.
Mutual funds with growth option
In the case of the growth option, the profits made by the scheme are not paid by way of dividend. Think of it as a cumulative option where profits are accumulated and reinvested into the mutual fund scheme. This means, when the scheme suffers a loss, the NAV falls. Conversely, when the scheme makes a profit, its NAV rises.
For example, you purchase 50 units of an equity fund at a NAV of Rs. 50. Assume the NAV of the scheme rises to Rs. 100 under the growth option in one year. You sell the units and receive a sum of Rs. 5,000. Hence, your profits from the investment are Rs. 2500 (Rs. 5,000 – Rs. 2500)
Which option is suitable?
When the markets are at an all-time high, the dividend option works the best. This is because, as the mutual funds’ scheme perform well consistently, and the NAV continues to rise, the likelihood of the fund managers declaring a dividend is higher. Also, if you require a regular source of income, a dividend option can prove beneficial for you.
The growth option can be a favourable choice if you have a long-term investment horizon in mind and not depending on your investment for regular income. This can help accumulate a corpus fund for your retirement in the future.
How are different options taxed?
For the dividend option, a rate of 10% dividend distribution tax (DDT) is imposed on equity-oriented mutual funds. This is not taxed in the hands of the investors but gets deducted and paid by the fund manager. However, the DDT may reduce your return on equity funds.
For growth option, long-term capital gains (LTCG) over Rs. 1 lakh on equity funds are taxable at the rate of 10%.
How to switch from dividend to growth option?
It is possible to switch from dividend to growth option and vice-versa. This would require you to sell your old units and purchase new units. It could also attract an exit load along with a tax on capital gains.
Thus, it depends entirely on your financial needs, whether to choose a dividend option or a growth option. Being an investor who knows what is a mutual fund and the types of mutual funds, you can choose from liquid funds, debt funds and balanced funds to create an ideal mutual fund investment portfolio.