Dividend or Growth-Which mutual fund investment option should you choose?

Last Updated : June 23, 2016, 12:01 p.m.

After reading a wide range of schemes, you finally decide to take one mutual fund after assessing your risk profile, return profile and comparing the performance of different funds. But even after selecting the mutual fund, you started pondering whether to take dividend option or growth option. Adding to your confusion was the dividend re-investment option. Just as selecting the right mutual fund is vital to your cause, similarly the selection of right option will stand you in good stead. So, let’s take a look at both the options and find out the better thing to go with.

Dividend Option

Investors receive dividend on their mutual fund investments with dividend option. As equity market is volatile, dividend option can be ideal for someone investing in debt funds. Also, debt mutual funds with dividend option suit senior citizens who want a steady flow of income apart from the appreciation of the capital. However, the power of compounding here is not much efficient because of the payouts. Moreover, investors who are not dependent on the income via dividends will most likely be reinvesting the proceeds in an asset class that will offer higher returns, won’t they. But, you must keep in mind that there is no assurance whether you will get dividends. Moreover, dividends are not declared sometimes in the entire year.

Dividend re-investment option

Dividend re-investment means whatever dividends you earn from the mutual fund investments will get reinvested for the appreciation of the capital. But, there comes the risk of paying the entry load during the re-investment of dividends. The entry load gets charged each time dividend gets reinvested. And if there is lock-in period for the investments, then your capital will remain locked for the set period.

Growth Option

You don’t get any short-term income while going with the growth option of mutual fund investments. Whatever money you may have invested will continue to get invested till it gets redeemed. This results in both capital appreciation and returns. However, you are not supposed to receive regular income with this option. For instance- You bought 1,600 mutual fund units at a price of Rs 15 and sold at Rs 22, so the capital gain and the returns will be Rs 11,200.

Equity mutual fund investors with long-term approach can make a lot of money with the growth option. The reason being long-term capital gains are tax-free. Another reason why this option is for long-term equity mutual fund investors because of the short-term risk that it can have on the returns. But in the long-term, you can get good returns. Further, you can take the benefit of power of compounding, which offers returns not only on the principal capital invested but also the notional profit. Investors, who do not generally rely on the monthly income on the investments, can choose this option. And since the payout of dividends is not there, you can get a higher net asset value (NAV) in the growth option compared to that of the dividend option.

Let’s also look at the aspect of taxation with respect to both the options.

Taxation

Like we said earlier, there is no taxes on long-term capital gains on growth funds. But short-term capital gain is taxed at 15%. If you invest in debt funds with the growth option, then you will have to pay short-term capital gain tax at 30%. While long-term capital gains attract tax rate of 10% and 20% without indexation and indexation, respectively. Indexation is a tool that helps adjust the purchase price of mutual fund in accordance with the prevailing inflation. When you choose the dividend option, the dividend remains tax-free for the investors. However, the fund needs to make the payment of dividend distribution tax (DDT) before giving the dividend.

Key Takeaways

• Dividend option remains tax-free for the investors and are ideal for short-term debt funds
• You won’t get any interim dividends but get capital gains with the growth option
• Growth option is ideally suited for long-term equity investments

Now, you have got a pool of information regarding both growth and dividend options of mutual fund investments to decide which is the best one for you. Choose the option taking into account your investment objectives, risk profile, your needs, etc.