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Tuesday, November 20, 2012

Growth or Dividend fund option-which one suits you!

Dividend Growth which one to choose?

When my mom had suggested me to start an SIP investment in mutual funds last year,i left it up to her to choose the fund house as well as deal with the other intricacies.But not everyone is as lucky as me,to have a mother who is connoisseur of all this stuff so that i don't have to fret over it.In this post i will list out some benefits of both the scheme options which might help a lot of investors to decide which one suits them better.There was an excellent article posted in economic times earlier, a lot of statistical data is presented from there in this blog.
                       To choose the right mutual fund is a fight in itself and then when you are asked whether you want the Growth or the Dividend option,you feel is it even worth the effort.Understanding these options is a one time effort and a little research here and there is all that is needed.Just as i mentioned in my previous post,an SIP investment in a good mutual fund is probably the best option you have to beat inflation in the long run.Keep investing and monitor your portfolio from time to time;you will reap the benefits sooner or later.
                       Three factors standout in your choice of growth vs dividend option : investment goals,financial needs and tax liability you would incur on your returns.Almost every mutual fund offers 3 options for a new investor - Growth,Dividend payout and Dividend reinvestment.If you don't choose an option , the scheme has a default option but you can switch to other option in future.
                       If you choose the growth option,the scheme does not pay you any dividends but continues to grow.The gains that are made by selling any holdings are ploughed back into the scheme.All the gains are reflected in the Net Asset Value(NAV) of the scheme which rises over time.Since no dividends are paid back to the investors,the NAV of the growth scheme is usually higher than the corresponding Dividend option.Investors under this plan earn returns by selling off their units at a higher NAV at a later date.
                      If you choose the Dividend payout option,the fund house pays you dividend at periodic intervals from the profits.The dividend paid to the investors is solely based on the performance of the fund and the company is not under any obligation on the regularity and the amount of these dividends.Thus,one can expect higher dividends if the fund is doing very well against meager amounts in not so merry situations.One thing to clearly understand is that there are no additional benefits offered under this scheme.The dividend returned is your own money;every time the company pays dividend to its investors the Net Asset value gets readjusted accordingly.In short this scheme can be termed a cash back option where you get the profits periodically but at the same time your investment corpus also gets readjusted which is reflected by a lower NAV.
                     In the dividend reinvestment plan,instead of paying the dividend to the investor,it is used to buy more units in the scheme.With every dividend the number of units held by the investor increases.The NAV of the scheme is readjusted once the dividend is paid to the investor.Once the NAV is adjusted,both the Dividend payout and Dividend reinvestment plan end up with the same NAV.Now one may wonder what's the difference between the 2 dividend options: in the Dividend reinvestment plan,each reinvestment is treated as a fresh investment and thus if the fund has a lock in period,the investment may remain locked in the fund.This is applicable to the close ended funds such as ELSS,FMPs,capital protection funds.Thus,it is imperative you are aware of the scheme's lock in period if you intend to invest in such a scheme with dividend reinvestment plan.
                     For some savvy investors the information presented above may be enough for them to decide which option suits them but for others,i reckon you can read on.Which option to choose depends on your needs and financial goals:if you are in need of regular income and cannot keep investing for long time,you can choose the dividend option.Be aware though,taking out investment and then keeping it in savings bank account is a waste.Thus you should choose the dividend option only if there is a need of regular income.In the Growth option,the power of compounding comes into picture.Since there are no dividends paid under this scheme,the invested amount is higher and is sure to fetch much better results if the fund performs well and you stay invested for a significant amount of time.So the rule is simple:
Is regular income needed - If Yes then dividend option,if No then Growth option.
                    Finally,you should know the tax implications of such schemes as well.Dividends from Equity funds such as Mutual Fund schemes are tax free but there is a Dividend Distribution Tax,also known as DDT,payable on Dividends from Non-Equity funds such as Debt,liquid and MIP funds.For MIP and Debt funds,the DDT is 12.5 % but in case of liquid funds it is 25 %.Based on this information here are some suggestions - if you invest in a debt fund for less than an year and fall in 10 % tax bracket,you can opt for growth option since the DDT will be 12.5 % for Dividend option.If you are in 20/30 % tax bracket,you should choose the Dividend option.The capital gains are added to your income for short term investments and then taxed as per you tax bracket ,so choose wisely.Choose the growth option,if you intend to invest in debt funds for more than an year.For such investments the returns are taxed at flat 10/20 % after Inflation Indexation,and thus better than investing in Dividend funds.Avoid Dividend option if you are investing in a liquid fund,remember the DDT is 25 %.For Equity and balanced funds,if you plan to invest for less than an year,you should opt for the Dividend option since the returns do not attract any DDT as of now.Even if the rules are changed under DTC,it is speculated that the tax will not be more than 5 %.If you plan to invest for more than an year in Equity/Balanced funds,go for the Growth option,since long term gains from such funds are currently tax free.

Keep investing prudently.

Images courtesy Google images.


  1. Hey Ankush,

    I happened to drop by your blogpost through some Google search and found it really interesting. You have posted some really useful information.

    Do not mind, but a piece of free advice ;) I suggest you to change the font of your page and make it look more spacious. Since you write longer posts, after some lines it becomes difficult to concentrate on the content. It will help you to glue your readers for a longer time. User experience does matter you see. :)

    And keep writing such informative stuff.

    Happy Writing..Cheers!

  2. Thank "Anonymous"
    Really appreciate you dropping by and appreciating my post!
    Thanks for mentioning that its difficult to read the posts with the current size.I have updated the font size and type on each of my posts and hope its a bit better now.
    You are always welcome to comment and make this blog better!!!
    Thanks much.

  3. Looks great Ankush! Why don't you put a space between two paragraphs O=:-)

  4. Thanks Adam for dropping by and appreciating my post.


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