Investors are often confused over what to select among ‘growth’, ‘dividend’ and ‘dividend reinvestment’ option. And the main reason behind it very few knows the difference bewteen the above. If you don’t select any of these options, the fund house will select the default option for that scheme as mentioned in the application prospectus. However, you can always change the option later. So, let’s understand some simple rules that you can follow in making the right choice.
This is a simple and straight forward option wherein you invest your money in a fund and let it grow. You do not get any returns till the time you withdraw from your fund either fully or partially. In this option, your NAV also increases and irrespective of dividend declared under the dividend option of the same fund, your NAV under the Growth Option is not affected as you have not chosen to use your appreciated money from the fund. The dividend and profits accumulate under this option. Growth option in simple words is something that keeps growing and compounding and until and unless you withdraw from it, you do not get to use the returns. Growth option is considered better option for retirement.
Unlike the growth option, investors opting for the dividend option will get a payout in the form of dividend. This option is ideal for short term investments, especially in debt. Debt mutual funds with dividend options are a good option for senior citizens who require a steady income flow and not only capital appreciation.
This option will give the investor the benefit of moderate capital appreciation along with dividend returns over the period of holding. It is important to note that due to the payouts, the power of compounding is not as efficient as compared to that of the growth option. Also, investors who do not depend on the dividend income, will face the risk of re-investment, i.e. re-investing the money earned via dividend in an asset class which offers good return.
It is important to keep in mind that dividends are not guaranteed, and also that sometimes no dividend is declared throughout the year.
Dividend re-investment option
This option tries to make the best of both worlds, in the form of declaring dividends to investors, but not issuing the dividends in the form of cash but re-investing the dividends into the same mutual fund for additional units. One faces the risk of having to pay an entry load each time a dividend is reinvested, and also if there is any lock in (as in the case of an ELSS), the new units will be subject to a further 3 year lock in. The growth option is a better bet than the dividend reinvestment option.
Taxation on growth funds is simple, as only capital gains are calculated, and for equity funds there is no tax on long term capital gains, while for short term capital gains it is 15%. In the case of debt funds in the growth option, short term capital gains is taxed at 30% whereas Long term capital gains is taxed at 10% without indexation or 20% with indexation. However, in the case of dividend options, the dividend is tax free in the hands of the investor, but the fund will have to pay dividend distribution tax before it gives the dividend.