Matter of Choice Growth or Dividend

When a new investor decides to invest in mutual fund scheme they come across variety of products and options, and often an uncertainty or dilemma is faced as to whether they should opt for Growth Option or Dividend Option. The uncertainty increased further once a person explores the dividend option as now he has to choose between a Payout Option and Reinvestment Option.

The selection of the option is a product of the investor’s knowledge and needs. While we can’t do much about the needs of the investors, we can definitely reach out to such audience and provide then with the needed knowledge.

Growth Option:

Under this function there are no dividends distributed on the units of the mutual funds scheme. The investor would get the benefit of appreciation in from of capital gains from this option.

Dividend option:

Dividend Reinvestment option:

A Dividend reinvestment plan (DRIP), offered by mutual funds, allows investors to reinvest their regular dividends in the mutual fund scheme. If the investor opts for the dividend reinvestment plan, the mutual fund will not send the dividend cheques but instead, the money will be used to purchase additional units on the mutual fund scheme.

Dividend payout option:

Under this plan the investor who has opted for dividend payout would receive the dividend money. All the investors on the given record day of the dividend will get the dividends paid. Further, the NAV of the respective scheme would fall to the extent of the dividend declared after the dividend is declared on the ex-dividend date. The gains to the investor would be in two forms- (a) dividends and (b) capital gains, if any.

The distinction between these options can be further explored by looking at a numerical exam below.

For example:

Amount for investment: Rs. 10000

NAV: Rs. 10

Annual appreciation: In 1^st year – 30%

In 2^nd year – 20%

Under Dividend Option: Dividend declared 20% (Rs.2 per units)

From the above table it can clearly see that Growth and Dividend Reinvest are almost the same while in case of Dividend Payout option returns are lower because whatever is gained, that is the dividend received is consumed or taken away from the investors from the portfolio. An important observation is that between Growth & Dividend Reinvestment, the NAV increases in the Growth option while in latter, it is the units that increase such the portfolio values remain the same. Further, a person who has chosen the Dividend Payout option is clearly loosing on the benefits of compounded returns as his / her investments are “liquidated” at regular intervals in parts.

The Tax impact:

Another aspect to look at while making the choice between options is to look at the tax impact. This is important since the tax treatment is different for

(a) Dividend and Capital Gains

(b) Holding period – Long-term and Short- term

(c) Nature of Fund – Equity. Debt and Liquid Funds

The table below gives the taxation under different scenarios: (For individuals & HUFs)

The Myth: Dividend is something extra:

People like to receive money and this is true even they receive dividends. There are many investors, who are not too familiar with mutual funds, who feel that with dividends they have gained something more. It is something extra in addition to the usual NAV appreciation. However, this is clearly a false myth.

A mutual fund scheme always declares a dividend as a percentage of its face value of Rs. 10. Face value is the price at which a single unit was issued when the scheme was started. So when a mutual fund declares a dividend of say 50%, what it means is that an investor gets a dividend of Rs 5 (50% of Rs 10) per unit as a dividend from the distributable surplus of the fund. After the dividend is declared the net asset value (NAV) of the mutual fund falls by the amount of the dividend declared. So if a mutual fund declares a dividend of Rs 5 per unit, and the NAV of a single unit before the dividend declared is Rs 20, then after the dividend declaration the NAV would normally fall to Rs 15. What the investor gains as a dividend he loses from the NAV. If he had sold the unit before the dividend was declares he would have got Rs 20 per unit. If he sells the unit now, he will get Rs 15 per unit. Rs 5 he has already pocketed as dividend. What this effectively means is that the mutual fund is returning the investor his own money not something extra.

Making the Choice:

The choice between the dividend and growth option should not be entirely made on the benefits of each options but should be based on your own

(a) Investment horizon

(b) Tax status and

(c) Risk profile

Growth / Dividend reinvestment option: ideal for investors looking for capital appreciation or wealth creation over time and for those who are not interested in getting “dividend” at regular intervals

The Dividend Pay-out Caveat:

While choosing a dividend-payout option, please note that the fund house is not obliged to declare at specific dividend intervals (unless it is pre-decided) so there is no assurance as to the timing and the extent of dividends. Further, if an investor really wants money, he/she can always redeem a part of his/her investments when the need arises or simply opt for a SWP or a systematic withdrawal plan (it is like the opposite of a SIP) which will give you some money at regular intervals.