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Which Is Better Option; Growth, Dividend Payout or Dividend Reinvestment?

Mutual Funds797 views

Highlights

  • Wondering which to choose from - Growth, Dividend Payout or Dividend Reinvestment Options? Let your investment objective choose the option for you
  • Greater tax savings make financial experts advocate for growth option

Mutual funds, be it equity or debt funds, offer you 3 broad plans; growth, dividend payout and dividend reinvestment plans. You can choose the plan based on which suits your needs the best. Each plan has its own implication in periodicity of returns, relevance for financial planning and tax efficiency. Let us look at the concepts.

Growth Plan

Growth plan of a mutual fund does not offer any payout. Profits made on the portfolio are necessarily ploughed back into the scheme. These growth plans are continuous compounders of your wealth.

Dividend Payout Plan

In this plan, the fund declares dividends out of profits. A fund can pay dividends only out of profits and not out of capital. That is applicable to equity funds and to debt funds. The NAV of the dividend plan reduces to the extent of the dividends paid, which is why you will find the NAV of a dividend fund always lower than a growth plan.

Dividend Reinvestment Plan

Let us start by understanding that this plan is not very popular and hence most funds do not offer this scheme at all. In a dividend plan, the dividends are paid out in cash to the unit holders. However, in the dividend reinvestment plan, the mutual fund buys units to the extent of the dividend declared by the fund at the post-dividend NAV and credits units to the account.

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Let us now look at a live illustration:-

In this table, the 3 different plans of Premium Equity Fund have been compared in terms of their value and the number of units pre and post dividend.

ParticularsGrowth PlanDividend Payout PlanDividend Reinvestment Plan
Units Bought100001000010000
Date of Purchase NAVJan 1, 2018Jan 1, 2018Jan 1, 2018
Purchase NAV₹10₹10₹10
Invested Amount₹1,00,000₹1,00,000₹1,00,000
NAV as on Dec 31, 2018₹14₹14₹14
Value of Investment₹1,40,000₹1,40,000₹1,40,000
Dividend DeclaredN.A.₹2₹2
Dividend Paid OutN.A.₹20,000N.A.
Units Issued in Lieu of DividendsN.A.N.A.1666.67#
Post Dividend NAV₹14₹12₹12
Post Dividend Units100001000011666.67
Post Dividend Value₹1,40,000₹1,20,000₹1,40,000

# – Dividend of 20,000 (10,000 x 2) will entitle him to 1666.67 units to 20,000 /NAV of 12

Some Key Takeaways from the Analysis of These 3 Different Plans

The number of units remains the same in the case of the growth plan and the dividend payout plan. However, in the case of the dividend reinvestment plan, the number of units increase due to fresh units allotted in lieu of dividends.

The post dividend NAV will be the same in the case of the dividend payout plan and the dividend reinvestment plan. The only difference between the two is that in one the dividends are paid out in cash and in other, the dividends are paid out in units of the fund.

In value terms, the reinvestment plan is the same as the growth plan since in both the cases the dividends have been reinvested into the fund. It is just the method of reinvestment that has changed. With equity dividends now attracting dividend distribution tax (DDT) at 10%, the attractiveness of dividend reinvestments could reduce even further.

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3 Points Agenda: Which Plan Should You Prefer?

Here are some interesting pointers on how you should go about selecting your plan: –
For long term financial planning, growth plans are the best. You automatically reinvest the money into the fund and the power of compounding really works in your favor. That suits your purpose too.

What about the tax aspects Let us look at equity funds. If you invest in growth funds then the short term capital gains will be taxed at 15% (held for less than 1 year). Long term capital gains (held for more than 1 year) will now be taxed at 10% without indexation to the extent your LTCG exceeds Rs.1 lakh in a fiscal year. In the case of dividend funds, the dividends will be tax-free in the hands of the investor but will attract DDT of 10%. This makes growth plans more attractive in terms of tax management.

In case of debt fund growth plans, STCG (less than 3 years) will be taxed at the peak tax rate but LTCG will be taxed at the rate of 20% after indexation. The DDT on dividend payouts on debt funds is 25% plus surcharge and cess. You can rather opt for a systematic withdrawal plan (SWP), which is more tax efficient.

The writer of this post is Mr Amar Rasali, he is a team leader in Mutual Funds division at Wishfin

Disclaimer – “Mutual fund investments are subject to market risks. Please read the scheme document carefully before investing”.