Mutual Funds: Growth vs Dividend
The investors may invest in mutual funds under two options: Growth option and dividend option. When the investors invest in growth option, they generate returns through the appreciation in the NAV of the mutual fund scheme. On the other hand, the investors under dividend option measure their profits in terms of both capital appreciation, as well as the dividend payout received by the investor.
Is the dividend an additional profit for the investor?
While dividends generally denote the additional returns for the investments in shares, the concept of dividend under mutual funds is not the same. Since the NAV of a mutual fund scheme represents the net assets of the scheme, any declaration of dividend reduces the NAV to that extent, along with tax implications and effectively, the valuation of the portfolio too. In other words, the dividend payout may be considered as the partial encashment of the mutual fund investment.
Power of Compounding – Dividend vs Growth
SEBI Regulations require that the mutual funds must consider the dividend only out of the profits realised by the scheme. However, since the realised gains keep moving out of the investment portfolio under the dividend option, the investments may only generate simple absolute returns for the investors. On the other hand, the returns of the mutual fund stay invested within the scheme under the growth option and hence, the investors benefit from the power of compounding, i.e. ‘returns from the existing returns’.
Systematic Withdrawal Plan – Regular and Certain Cash Flows
While the dividend option is considered suitable for the investors with regular cash flow requirements, an essential element missing under the dividend option is the certainty. The investor, as well as the mutual fund scheme, does not have control on the quantum as well as the periodicity of the dividend payouts.
Systematic Withdrawal Plans (SWP) may be a better alternative for such investors, as the investor stays in complete control of the quantum and periodicity of such cash flows. While in case of the dividend payout, the number of units stays the same while the NAV decreases. On the other hand, under SWP, the NAV remains the same while the number of units keeps on reducing with each periodical withdrawal.
Taxation under Growth Option and Dividend Option – Equity Funds
Under the growth option, the investors will generate returns in the form of capital gains, which are taxed at 15% if the investment is redeemed within 12 months of investments and at the rate of 10% (for the gains beyond Rs. 1 lakh) if the invested period is longer than 12 months. On the other hand, while the dividends received from equity funds are exempt in the hands of investors, the dividend payout is subject to dividend distribution tax (DDT) of 10% and such tax also reduces the NAV to that extent. So, if the mutual fund declares a dividend of Rs. 10 per unit, the NAV reduces to the extent of Rs. 11 (Rs. 10 plus 10% DDT Re. 1). As such, there is indirect taxation for the investor.
Switching from Dividend option to Growth option or Vice Versa
While the investor may have chosen a particular option to be more suitable considering the financial goals, investment horizon, cash flow requirements etc., there remains a possibility that he/ she may wish to switch the investments from one option to another. While one may transfer the investments from one option to another quickly, the investor must consider the exit load implications, if applicable as well as the incidence of tax on such transaction.
While no option may be considered as the ideal option for all the investors, you must make an informed decision while making the mutual fund investments, since this may have long-term implications on their financial future.
Disclaimers: The information set out above is included for general information purposes only and is not exhaustive and does not constitute legal or tax advice. In view of the individual nature of the tax consequences, each investor is advised to consult his or her or their own tax consultant with respect to specific tax implications arising out of their participation in the Scheme. Income Tax benefits to the mutual fund & to the unit holder is in accordance with the prevailing tax laws/finance bill 2017. Any action taken by you on the basis of the information contained herein is not intended as on offer or solicitation for the purchase and sales of any schemes of UTI mutual Fund. Please read the full details provided in SID and SIA carefully before taking any decision.
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