Mutual fund investments come with a few options as far as dividends are concerned. You can go for the dividend payout option, where the dividend is paid to you as and when it is declared by the fund. You can also opt for the growth option, where the profits are reinvested in the fund as and when declared.
Choosing a proper option is essential. There are many factors that guide you on this. The two major considerations are your cash flow requirements and the tax implications.
Dividend option
In this case, the fund does not reinvest the profits. You receive the dividends as and when declared by the mutual fund. So, there is a continuous flow of funds. This option suits those who invest with the objective of receiving a continuous stream of income. Also, you have the flexibility of investing the dividends in other options. You can then diversify your portfolio, rather than restricting it to one particular fund.
The dividends can be invested in other funds or fixed income options. The only hitch is the dividends are not guaranteed. You may get good returns one year and nothing in another one.
Dividends from a mutual fund are not taxed. However, the fund pays a dividend distribution tax (DDT). The rate of DDT in case of liquid funds is 25 percent (plus surcharge or cess). For non-liquid fixed income funds, the DDT for individual investors is 12.5 percent (plus surcharge or cess).
Growth option
In this case, all the profits made by the fund are ploughed back into the scheme. This causes the NAV of the fund to rise over time. In case you don't have an immediate requirement for funds, you can go for the dividend reinvestment option. The dividends declared are reinvested in the same fund. The number of units is increased.
The reinvestment is made at the market price of the units prevailing on the date of dividend reinvestment. So, you do not receive any immediate cash.
The NAV of this option will always be higher than that of the dividend option because money is going back into the scheme and not given to investors.
You can make money later by selling the units at a higher NAV.
If you are looking at a long-term investment option and if you are not interested in returns at regular intervals, this is a better option.
In the growth option, the gains are taxable in the hands of the investor. There is no DDT. The tax depends on the holding period - returns from mutual fund units held for a period of less than a year are called short-term capital gains (STCG), and from a holding of more than a year are long-term capital gains (LTCG).
STCG is taxable at the slab rate applicable to you. In case of LTCG, you can pay income tax either at 10 percent (plus cess) without taking the benefit of cost inflation indexation or at 20 percent (plus cess) after taking the benefit of cost inflation indexation.
So, if you are planning to invest for less than a year, the dividend option is better as the individual DDT rate of 12.5 percent is lesser than the STCG rate of 30 percent. However, in case you are planning to invest for a longer term, the growth option is advisable. In case of the growth option, the tax rate of 10 percent (without indexation) is lower than the DDT rate.
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