When choices are many you could end up feeling confused; it could be over buying a cell phone or for that matter an ice-cream flavour!
So imagine, when your mutual fund (MF) agent throws an array of questions -- Which fund do you want to invest in? or Which MF option do you want? Chances are you might end up feeling confused.
A MF offers three options-- dividend payout, dividend reinvestment and growth. Each of this option has its own pros and cons. We at Wealth tip you off on what's best for you.
Let's understand the three options in detail.
A. Dividend payout:
Assuming you have 100 units in your MF and the net asset value (NAV) of the unit is Rs 10. Now, the fund house declares 50 per cent dividend (a dividend is the profit made by a MF that it distributes to its unit holders. These dividends are paid in cash and are a percentage of the unit value) on the scheme. So, for every unit you will get Rs 5 (50% of Rs 10), which makes it Rs 500 for 100 units.
You might rejoice at the thought of getting some extra moolah but the catch lies in the fact that the NAV of the unit will fall exactly by the amount of the dividend declared. This means, if the dividend paid out is Rs 5, the NAV will fall to Rs 10 from let's say Rs 15. In other words, your own money is paid back to you in a different way. It is called the dividend payout option.
When should you opt for it?
Tax implication: The dividends received in equity funds or balanced funds are tax-free.
However, there is a slight difference when it comes to debt funds. When a debt fun declares a dividend, the mutual fund house must pay a dividend distribution tax of 14.16 per cent. As a unit holder, you do not have to pay tax on the dividend. But eventually the dividend distribution tax has a bearing on the returns.
Best suited for: This option is best suited if you are looking for cash at intervals. But there is no surety if the MF will announce dividends, and even if it does, the next dividend payout is uncertain.
By choosing the dividend payout option, you may end up interfering with the returns in the long term. When you pull out a part of your money in advance, you deprive yourself of taking complete advantage of the bull market that could give you good returns.
B. Dividend reinvestment:
In this option, the dividend paid out by the fund is ploughed back into the same scheme. Let's understand this with the same example described above. If the dividend declared is 50 per cent on per unit priced at Rs 10; for the 100 units held, Rs 500 will be the dividend. Now, this Rs 500 will be used to buy new units at the old NAV ie at Rs 10. This means, you will have additional units in your fund.
Tax implication: Let's say, your equity linked saving scheme or ELSS declared dividend and you have earned Rs 500 on it. This amount will be used to buy new units and will be reinvested back into the scheme. This same amount ie Rs 500 will be considered as an additional investment under section 80C. However, as we discussed above, the declaration of dividends depends on the performance of the fund and these dividends are not guaranteed.
This benefit is applicable only on ELSS funds since only these funds offer a tax deduction under section 80C. Debt funds do not offer any such tax benefit. On the contrary, the amount of dividend reinvested would be less thanks to the dividend distribution tax.
Best suited for: If you are looking for tax benefits then you could consider this option. Like explained above it helps you to get additional tax benefits under section 80C, and also help you save! This means when the additional units are reinvested back into your scheme, you do not have to pay any entry load on it, which otherwise is applicable.
C. Growth:
Unlike the payout or reinvestment, growth option doesn't pay you any dividends. So, if the dividend declared is Rs 5 on each unit priced at Rs 10, the NAV will appreciate to Rs 15.
Tax implication: In growth funds the important tax to consider is capital gains tax - that is the tax that is charged on profits from sale of the units.
In case of equity and balanced funds (where equity exposure is more than 50 per cent), there is no long term capital gains tax (that is there is no tax if you sell after 1 year). If you sell before 1 year, you will have to pay short term capital gains tax on the profits at the rate of 15 per cent.
In case of debt funds, long term capital gains tax is charged at 20 per cent and short term capital gains tax is charged at your regular tax slab.
Best suited for: If you have a long-term approach you can consider it. Since the NAV will move up in the long run, the growth option outperforms its counterparts—payout and reinvestment options. From the long term perspective, this option is ideal.
From the expert: If you are focused on getting profits, then you must stick to reinvestment or growth option. By choosing the payout option, you erode your returns that you are likely to get in the long run. If you take any long operating mutual fund, the difference of NAV between growth and payout option is really wide. Hence, it is advisable to choose a reinvestment or a growth option.
So imagine, when your mutual fund (MF) agent throws an array of questions -- Which fund do you want to invest in? or Which MF option do you want? Chances are you might end up feeling confused.
A MF offers three options-- dividend payout, dividend reinvestment and growth. Each of this option has its own pros and cons. We at Wealth tip you off on what's best for you.
Let's understand the three options in detail.
A. Dividend payout:
Assuming you have 100 units in your MF and the net asset value (NAV) of the unit is Rs 10. Now, the fund house declares 50 per cent dividend (a dividend is the profit made by a MF that it distributes to its unit holders. These dividends are paid in cash and are a percentage of the unit value) on the scheme. So, for every unit you will get Rs 5 (50% of Rs 10), which makes it Rs 500 for 100 units.
You might rejoice at the thought of getting some extra moolah but the catch lies in the fact that the NAV of the unit will fall exactly by the amount of the dividend declared. This means, if the dividend paid out is Rs 5, the NAV will fall to Rs 10 from let's say Rs 15. In other words, your own money is paid back to you in a different way. It is called the dividend payout option.
When should you opt for it?
Tax implication: The dividends received in equity funds or balanced funds are tax-free.
However, there is a slight difference when it comes to debt funds. When a debt fun declares a dividend, the mutual fund house must pay a dividend distribution tax of 14.16 per cent. As a unit holder, you do not have to pay tax on the dividend. But eventually the dividend distribution tax has a bearing on the returns.
Best suited for: This option is best suited if you are looking for cash at intervals. But there is no surety if the MF will announce dividends, and even if it does, the next dividend payout is uncertain.
By choosing the dividend payout option, you may end up interfering with the returns in the long term. When you pull out a part of your money in advance, you deprive yourself of taking complete advantage of the bull market that could give you good returns.
B. Dividend reinvestment:
In this option, the dividend paid out by the fund is ploughed back into the same scheme. Let's understand this with the same example described above. If the dividend declared is 50 per cent on per unit priced at Rs 10; for the 100 units held, Rs 500 will be the dividend. Now, this Rs 500 will be used to buy new units at the old NAV ie at Rs 10. This means, you will have additional units in your fund.
Tax implication: Let's say, your equity linked saving scheme or ELSS declared dividend and you have earned Rs 500 on it. This amount will be used to buy new units and will be reinvested back into the scheme. This same amount ie Rs 500 will be considered as an additional investment under section 80C. However, as we discussed above, the declaration of dividends depends on the performance of the fund and these dividends are not guaranteed.
This benefit is applicable only on ELSS funds since only these funds offer a tax deduction under section 80C. Debt funds do not offer any such tax benefit. On the contrary, the amount of dividend reinvested would be less thanks to the dividend distribution tax.
Best suited for: If you are looking for tax benefits then you could consider this option. Like explained above it helps you to get additional tax benefits under section 80C, and also help you save! This means when the additional units are reinvested back into your scheme, you do not have to pay any entry load on it, which otherwise is applicable.
C. Growth:
Unlike the payout or reinvestment, growth option doesn't pay you any dividends. So, if the dividend declared is Rs 5 on each unit priced at Rs 10, the NAV will appreciate to Rs 15.
Tax implication: In growth funds the important tax to consider is capital gains tax - that is the tax that is charged on profits from sale of the units.
In case of equity and balanced funds (where equity exposure is more than 50 per cent), there is no long term capital gains tax (that is there is no tax if you sell after 1 year). If you sell before 1 year, you will have to pay short term capital gains tax on the profits at the rate of 15 per cent.
In case of debt funds, long term capital gains tax is charged at 20 per cent and short term capital gains tax is charged at your regular tax slab.
Best suited for: If you have a long-term approach you can consider it. Since the NAV will move up in the long run, the growth option outperforms its counterparts—payout and reinvestment options. From the long term perspective, this option is ideal.
From the expert: If you are focused on getting profits, then you must stick to reinvestment or growth option. By choosing the payout option, you erode your returns that you are likely to get in the long run. If you take any long operating mutual fund, the difference of NAV between growth and payout option is really wide. Hence, it is advisable to choose a reinvestment or a growth option.
