The mutual fund industry is quite broad. You may find it confusing which scheme could be the best one to meet your objectives as you have several options. Each fund has its benefits and drawbacks. When selecting a mutual fund, you will be required to choose between a dividend or growth option. Read further to know more about it.
Every mutual fund scheme comprises of two options – Growth Plan and Dividend Plan.
A mutual fund that invests in growth stocks to attain capital appreciation is called growth mutual fund. The fund comprises of companies that have significant returns potential and fast-paced progress.
The growth options are high-risk investment instruments, and it is only suitable for individuals who have an aggressive investment strategy.
The capital appreciation is quite high; hence it attracts the attention of maximum investors. A team of qualified professionals spend considerable time in choosing growth stocks
The long-term capital gains or LTCG from growth funds attract a tax rate of 10% if you earn Rs. 1 lakh or more in a year
The expense ratio of these types of funds is also high
The funds have the potential to grow exponentially.
A dividend option in a mutual fund consists of three variations – dividend payout, dividend reinvestment and dividend sweep. Dividend payout is a part of the profits that a company pays in dividends to shareholders. In contrast, dividend reinvestment plan allows investors to reinvest cash dividends in extra units of stocks. Dividend sweep will enable you to invest in the units of another mutual fund scheme managed by the same fund house. For instance, if you have invested in a fund which has net asset value (NAV) of Rs.14 and as the fund performs, its value appreciates to Rs. 16. The company pays Rs. 2 as a dividend. So again the NAV of the fund reaches at Rs. 14.
Features of Dividend Option:
The dividend option is a short-term investment mutual fund scheme
If you are a risk-averse in terms of mutual fund investment, the dividend option is an ideal choice
In the case of dividend reinvestment options, shareholders do not have to pay any fee for the dividends paid in cash
The fund doesn’t guarantee the amount and frequency of dividend payment
The fund manager declares dividends only when a company generates profits
When you opt for a dividend mutual fund plan, the fund regularly pays dividends depending on the profits, which in turn reduces the NAV of the fund. In most cases, investors do not reinvest these dividends and prefer to use for other purposes. This, in turn, diminishes their wealth creation capacity.
For long-term wealth creation, Growth Option is the best option due to the power of compounding. The profits generated by the growth option gets automatically reinvested by the fund.
Growth plans allow you to estimate returns, which enables you to predict long-term wealth creation amount. The mutual fund keeps you in sync with your financial planning.
Dividend option is best suitable for the retired section of the population and to those who are looking for regular income as it is characterised by low-risk appetite. If you have invested in dividend option, you will also attract Dividend Distribution Tax (DDT) at the interest rate of 29.12%, inclusive of surcharge & Cess.
In case of long-term capital gains earned from Growth Option, you will be charged at a tax rate of 10% if the earning is Rs. 1 lakh and it is held for more than a year. For short-term capital gains, the interest rate is set at 15% for holding less than a year.
The NAV of a fund in Growth option is high as compared to the dividend option. To invest in Growth option, you need to be a market-savvy person and have a high degree of risk tolerance. High risks mean high rewards.
Growth option mutual scheme is the best considering the taxation element and long-term financial planning. However, the decision varies from investor to investor.
Both Growth option and Dividend option in mutual funds can help you achieve distinct investment goals. If you’re looking for regular income generation, then dividend option would work for you; but the wealth accumulation will be slow as compared to the Growth Option. If you want to get high returns with high-risk appetite and you can continue investing for an extended period, then you should opt for Growth option.
The good thing about mutual funds is that you can switch from Growth option to Dividend Option. Before doing this, you should know about the exit loads and taxes you could face on capital gains.
Note that selection between the two depends on your risk tolerance level, your investment horizon and your budget.