How to Choose the Right Mutual Fund Option?

Everyone has some or other kind of financial goals, no matter how big or small these might be, which they want to accomplish. Mutual Funds, here may seem an easily achievable investment option to go for.

Table of Contents

1.)Benefits of Investing in Mutual Fund
2.)What is the difference between “Growth and Dividend Option in Mutual Funds”?
3.)What is the truth in Mutual Fund Dividends? Is it really attractive?
4.)What is the Growth Option?
5.Who can choose the growth option?
6.)Dividend Option:
7.)Dividend Re-investment:
8.)Growth and Dividend Option in Mutual Funds – How to Choose?
9.)Taxation:
10.)Growth and Dividend Options in Mutual Funds – Which is Better?

Benefits of Investing in Mutual Fund

The biggest advantage is Diversification. Each unit holder contributing in a small proportion becomes a part-owner of a large portfolio. This minimizes the risk by dividing the investments into many securities.

Through Mutual Funds, you get expert management for your investment and you can invest in small amounts. Since this is a collective investment, the cost of the management is very low, and most important is the liquidity aspect.

You can invest a fixed amount regularly (SIP) and save for your long-term goals. This concept of Rupee Cost Averaging will help you in averaging your cost of buying and which has given good returns in the past.

Also from the taxation point of view, Mutual Fund scores over other investments. Profits from the sale of Equity Mutual Funds after one year from the date of investment are considered as long-term capital gains and are taxed at only 10%.

There are many types of Mutual Funds in the market to confuse the investors. Your success lies in identifying the right fund and investing in it.

What is the difference between “Growth and Dividend Option in Mutual Funds”?

One may still be perturbed about choosing its growth option or dividend option. The confusion may even go to the next level, with the dividend reinvestment option coming into the picture.

You are often seeing advertisements from Mutual Fund companies regarding the announcement of Dividends. Agents will use this as an opportunity to sell such Funds at that time showing Dividends as an extra payout.

What is the truth in Mutual Fund Dividends? Is it really attractive?

Even if one has the right fund option in mind, he/she may think of additional factors like making the optimum asset allocation and accessing the risk appetite.

The selection of the right mutual fund option is as significant as the mutual fund itself. Therefore, before making a decision of any kind, it is beneficial to know about these options in detail. So, let us proceed towards the same.

What is the Growth Option?

While investing in a Mutual Fund, if you opt for the Growth Option, you are not eligible for any dividend. But the gains made by the Fund will be reflected in the value of your investment by way of a higher NAV.

This is the reason why the NAV of the Growth Plan is higher than the Dividend Option. You can enjoy such gains only when you sell the Fund.

Under this growth option, the investment will not yield any short-term income; rather the money will continue and will remain invested unless redeemed. Thus, this will fetch returns in the form of capital appreciation, not with a regular income.

Who can choose the growth option?

This type is very well suited for investments in long-term equity mutual funds with a motive of capital appreciation. Although equity mutual funds are prone to risks in the short term, in the long term they fetch good returns.

Additionally, since the fund does not have to pay out any monthly dividends, the net asset value from this is much higher than the dividend option for the same fund. However, one should note that the difference is only due to dividends payment, not the considerable variation in fund performance.

This option is suitable for those who are investing in a debt fund for more than a year and don’t seek regular income. By choosing a growth option in a debt fund, you are accountable for tax only when you withdraw. If you choose a dividend option in a debt fund, whenever they declare a dividend, you need to pay tax. This can be avoided by choosing a growth option.

Dividend Option:

In this option, you will be paid dividends out of the profits made by the Fund. But the declaration of dividend is at the discretion of the Fund House and is not guaranteed. Dividends are often declared as a percentage of the face value of the units.

Imagine, the current NAV of a Fund is 20 and it declares a 20% dividend today. It means an amount of Rs. 2/- per unit will be paid to you. (20% of the Face Value Rs. 10/-). But after the payout of this dividend, the NAV of the Fund will fall to Rs. 18/-, which is called the ex-dividend NAV.

So, in this case, you are not getting anything extra compared to the investor, who has opted for the Growth Option.

The dividend in Mutual Fund is not an extra benefit paid. The amount paid as a dividend is reduced from the NAV immediately. So, it is nothing but, returning a part of your own investment.

You will feel happy because you are getting that amount in hand, but to that extent, your savings is reduced.

This option lets the investors fetch payout in the form of dividends. The option holds good for short-term investments. Debt mutual funds with this option are good for senior citizens, who require a steady flow of income and not just capital appreciation.

With this option, investors have the benefits of moderate capital appreciation, in addition to the dividend returns in the holding period.

One should note that the compounding power is not as efficient as that of the growth option. Moreover, investors not depending on the dividend income, also have to face the risk of re-investing the dividend money in asset class offering good returns.

Keep in mind that this option does not have guaranteed dividends, and at times, it dividend may not be declared even for the whole year.

Dividend Re-investment:

It declares dividends but does not issue the same in the form of cash, but re-investment of that into the same Mutual Funds for fetching additional units. The growth option still seems a better choice.

Please don’t select the dividend reinvestment option. It will attract more taxes.

Choosing dividend reinvestment in ELSS schemes will put you into a continuous loop of the lock-in period. You will not be able to exit the scheme completely.

Growth and Dividend Option in Mutual Funds – How to Choose?

You should select the option, as per your financial goals and in line with your cash-flow planning. For long-term goals like your retirement, your child’s education, and your marriage, opt for the Growth Option to get the benefit of compounding.

If you opt for Dividend Option, the dividends paid will reduce the NAV and you may not get the desired amount for the long-term goal.

But, if you are looking for some cash-flow from your investments, then you can opt for Dividend Option. But please note, that there is no fixed frequency of payments in the Dividend Option. The Fund House will decide the amount and the date of the dividend.

Taxation:

Taxation on growth options for equity funds is a simple calculation, with only capital gains involved.

For equities, there is a tax for long-term capital gain at 10%, while only 15% for short-term capital gains. In the case of dividend options, the dividend is taxed at your tax slab rate.

For debt funds, you pay tax on dividends at your respective tax slab rate. For capital gain also from debt funds, you pay as per your tax slab rate.

The key points summarizing the debate over the selection of the right mutual fund option are:

• The growth option is purely a capital gain return investment, without any interim returns.
• Growth is good for equity and long-term investments.
• The dividend option has irregular dividend payouts., which are taxable in the investor’s hands.
• Dividends are best suited for short-term debt funds.

Growth and Dividend Options in Mutual Funds – Which is Better?

By now, you are clear about the difference between the two Options. Now, which option is better?

Since Mutual Fund investments are for long term, it is better to opt for the Growth Option both in Equity and Debt Mutual Funds. Dividends paid by Mutual Funds are not like Dividends paid in Shares.

Mutual Fund Dividend is nothing but the partial withdrawal of your money, at the discretion of the Fund House! In order to take better investment decisions and achieve your financial goals without fail, preparing a fundamentally strong, foolproof financial plan is required.

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