Dividend or growth option in mutual funds – Which is better?
Last week there were series of queries from readers enquiring whether Dividend or Growth option, which is better one in mutual funds. This is one of the key points for an individual to make investment decisions in mutual funds. Mutual funds offer two types of schemes, Growth and Dividend option. Both have their own unique features. In this article, I would detail about Dividend or Growth options in mutual funds, their features, and comparison of these two and how one can choose better option to grow their investment.
What is Dividend Option in Mutual fund?
Dividend option in mutual funds is where an individual would get regular dividend / Pay-outs. These dividends are not fixed and are not guaranteed. It would depend up on the performance of the mutual fund scheme. Some times in a year, you may not get dividend at all.
What is Growth Option in Mutual fund?
Growth option in mutual fund is where an individual would not get dividend or payout. The amount invested would grow over a period of time and is paid during redemption / selling. Profit is the difference between amount received during redemption and the amount invested.
Comparison of Dividend option and Growth option in Mutual funds
1) Dividend payout: Under dividend option, regular dividends are paid. As indicated above, the dividend is not guaranteed or fixed. On other hand, growth option does not pay any dividend. The amounts are paid after you sell the units.
2) NAV would be different: NAV for these two options would be different through the scheme is same. e.g. The NAV of HDFC Top-200 (Growth) is Rs 194.71 and NAV of HDFC Top-200 (Dividend) is Rs 34.72. HDFC Top-200 is single scheme managed by a single fund manager. No difference in investment objectives. Under dividend option, due to regular amounts get paid, the NAV would be always lower compared to Growth fund. People often miss-interfere saying NAV of HDFC Top-200 (Dividend) option is low and it may be underperformer which is not correct.
3) Taxation: Dividend option in mutual funds provides dividends which are tax free. Please note that fund has to pay tax of 12.5% (Dividend distribution tax) before the dividend comes to investor.
On the other hand, growth options in mutual funds are categorized into two.
a) Equity funds and equity related funds taxation: These funds invests majority of their portfolio in shares. If you sell the equity growth option mutual funds before one year, it is short term capital gain and taxed at 10%. If you sell such funds after one year, they are long term capital gains and the profits are tax free.
b) Debt funds taxation: Profits from debt funds within one year are added to your income and you need to pay tax as per your income tax slab. On other hand, profits from debt funds of over one year are taxed at 10% without indexation and 20% with indexation.
Dividend and Growth option in mutual funds – Which is better option?
Looking at the above features, it would be little confusing about which option to be chosen. Follow these simple rules if you have short term and long term investment objectives.
I) Long term investment (5+ Years) – Buy equity funds with growth option: You should invest in equity mutual funds with growth option for capital appreciation if you are long term investor. Equity funds invest in stocks for long term as stocks tend to provide good returns in long run. The returns are tax free.
II) Medium term investment (1 Year to 5 years) – Buy debt funds with growth option: If you are medium term investor, you should invest in debt mutual funds with growth option. The main reason is you would get higher post tax returns. You need to pay tax on profits for 10% without indexation and 20% with indexation. If you consider indexation, the tax which needs to be paid would be low.
III) Short term investment (< 1 year) – Debt funds with dividend option: If you are looking for short term investment, you should invest in debt mutual funds with dividend option. Under dividend option, mutual fund companies would pay 12.5% as dividend distribution tax. On the other hand, short term capital gains from debt mutual funds with growth option would be taxed as per individual income tax slab if sold within one year. If you are in higher tax bracket of 20% or 30%, you would end up paying more tax. Under dividend option, you would pay just 12.5% as DDT, hence you would save good amount of tax.
Conclusion: Even I made some mistakes earlier in buying debt mutual funds with growth option for < 1 year investment objective. Due to higher tax bracket, the post tax returns were very low. I felt the above points have to be considered to get higher post tax returns.
Readers, what is your investment strategy in mutual funds? Are you investing in growth or dividend option? Do you think there are any other points to be considered while choosing these options?
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Dividend or growth option in mutual funds