One of the biggest puzzles investors face while investing in mutual funds is in deciding whether to opt for growth, dividend payout and dividend reinvestment plans. Going by the description the dividend payout option may look lucrative, as I would meant getting a steady flow of money at regular intervals in the form of dividend payout. But it would make better sense to first understand the workings and benefits of each of these options before choosing any of these options.
So how do they work really? First all about dividend payout. When you opt for this plan, you will receive a dividend on cheque or as a credit to your pre-specified bank account whenever the scheme declares dividend. Now there is a catch in the dividend announcement itself. Mutual funds often announce their dividends as a percentage of the face value of a unit. So you would often hear about a certain mutual fund house declaring 80% or 100% dividend on a particular scheme and rarely is it expressed as a rupee amount. These numbers can be misleading unless you know the real meaning of it. So, it is important to note that a higher percentage, say, 80%, is only high as far as the face value is concerned. If the face value is Rs 10, then the actual dividend payout would be 80% of Rs 10 or Rs 8. At times the announcement says, a fund house has declared 100% of distributable surplus as dividend.
So what is this distributable surplus? Remember, dividend is distribution of gains and profits. Which means a mutual fund can declare dividend only when there is a profit. When you invest in a mutual fund scheme at an NAV, say 12, and if after sometime this NAV grows to Rs 13, then Re 1 is the distributable surplus and the fund house can declare it as dividend. So when the fund house is declaring 100% of distributable surplus as dividend, it is payout out this entire Re 1 gain to you. Accordingly, this amount will get deducted from your NAV, because you cannot receive the profit as well as let it stay invested in the fund.
But if you had opted for a growth plan, this Re 1 will not get deducted and the NAV will keep accumulating. Which means if you had bought 100 units of a fund at an NAV of Rs 12 by paying Rs 1,200, when the NAV becomes Rs 13, in case of 100% dividend payout, you would get Rs 100 as dividend while your investment will remain Rs 1,200 under the dividend payout plan with the same number of fund units (100). But under the growth plan, you will not get any payout but your investment will rise to Rs 1,300 with the same number of fund units (100).
Then comes the dividend reinvestment plan. It is somewhat similar to the dividend payout plan. But instead of the fund house paying you the dividend in cash, it will pay you in kind by buying more units of the same fund with the dividend payable. Accordingly you will not get any cash, but your investment will rise to Rs 1,300 with a higher number of units (108.33) of NAV Rs 12.