A mutual fund generally offers two schemes: dividend and growth. The dilemma that most of the Mutual Fund investors face is to choose between Growth or Dividend option.
The dividend option does not re-invest the profits made by the fund though its investments. Instead, it is given to the investor from time to time. Normally, the dividend option is chosen by those who would like to retain their investments in the mutual funds even while expecting periodic returns from it without actually redeeming any investment.
In the growth option, all profits made by the fund are ploughed back into the scheme. This causes the NAV to rise over time. To realise the growth in value or to meet financial needs, investors had to redeem the units. The earning is ploughed back into the scheme itself which is reflected in the NAV and as in the case of cumulative option in bank deposits, witnesses an exponential value growth over a period of time.
Both the options have their own advantages. Both are equally tax-neutral in that with the abolition of long term capital gains tax. For those opting for dividend option, the dividend declared by mutual funds would be tax free at the hands of the unit-holders.
Dividend Income payouts by Mutual Funds
Mutual Fund units are generally confused with equity shares listed on stock exchanges. This is especially true in the case of dividend payouts being made by funds. Most people are not aware that the Net Asset Value (NAV) of the fund reduces by the amount of dividend paid and that any repurchase offered after the dividend payout date is made at the ex-dividend value.
While even share prices are influenced by dividend payouts, demand-supply factors in a stock market can cause the price to move sharply up or down. This demand-supply factor does not impact fund unit value in the case of funds that are not listed on any stock exchange. And, most funds are unlisted open-ended funds.
What does all this mean to you as an investor?
If you decide to invest in funds after seeing advertisements announcing dividend payouts, you will not necessarily add to your wealth. However, it is important to remember that while investing in such funds purely to gain access to dividends may leave your wealth unchanged.
In case of debt or income funds dividend distribution also entails a tax. Even this tax is reduced from your unit’s net asset value.
So, which Mutual Fund option is better Dividend or Growth?
This brings the question as to whether you should opt for growth option or dividend option in a mutual fund. To anwser it you should be clear of your investment objectives. Those who invest from a capital appreciation point of view over long term should choose the growth option, those seeking regular income should pitch for the dividend option. But you should understand that the dividend payment is not assured and if there were no surpluses, there would be no dividend.
Dividend you recieve on your Mutual Fund scheme is not something extra. Your returns from a Dividend Option and Growth option are almost same. Generally, Dividend Payout is somewhat inefficient, as you lose the chance of compounding your returns (assuming that the dividend you receive is not invested but used up; which is the case with many investors)