Your Money: Select MF payout option wisely

Go for dividend reinvestment if you want to set off capital gains or losses against other gains or losses

Mutual fund investment can be simpler than direct equity investment as much of the analysis is fronted by the fund manager. Yet, there are decisions to be made apart from the typical equity versus debt or diversified versus balanced fund toss-ups. Choosing between the dividend and growth plan options of mutual fund schemes is one such area that can be deceptively tricky.

Dividend and growth options explained

Most mutual fund schemes have two options for investment: dividend and growth. The portfolio returns are the same for both options but the cash flows, payouts, number of units owned, liquidity, and taxability vary.

In schemes with dividend options, dividends are declared from time to time. The dividend option in turn has two options: dividend payout and dividend reinvestment. In the dividend payout option, the declared dividends are paid into the bank account of the investor. In case of the dividend re-investment option, the dividends are reinvested in the same scheme and additional units are allotted to the investor.

In the growth option, no dividends are declared. The investor does not receive any money in her bank account as long as she holds the mutual fund units. It is only when the mutual fund units are sold does she receive the full value of her investment.

Differences between the options

In the dividend payout option, the number of mutual fund units held does not change, but the price per unit or the Net Asset Value (NAV) reduces to the extent of the payout. In the dividend re-investment option, the NAV reduces as well as additional units are allotted to the investor since the dividends are invested back into the scheme.

In the growth option, since no dividends are declared, the NAV captures the full value of any gains (or losses) in the scheme’s value and will thus increase (or decrease) over time. The number of units remains unchanged.

The dividend payout option offers liquidity in terms of dividends paid whenever declared, whereas the dividend re-investment and growth options do not offer such liquidity. Also, certain mutual fund schemes have a Dividend Transfer Plan (DTP) feature wherein dividend earned in one scheme can be invested in another scheme of the same mutual fund. This is possible only if you have opted for the dividend option.

In terms of taxability, although there is no Dividend Distribution Tax (DDT) currently for the dividend option, the dividend income is taxable in the hands of the investor and is added to the taxable income of the investor for that assessment year. In case of growth option, any capital gains upon sale of the mutual fund units can attract capital gains tax based on the type of the scheme.

What investors need to watch out for
Investors needing regular income opt for the dividend option assuming that dividend income is assured. However, dividends are paid only if there is distributable surplus in the scheme, which means they are paid out of only realised profits after provisioning for expected losses in the scheme. Thus, dividend income is neither guaranteed nor regular.

When evaluating scheme performance in case of dividend option, ensure you are comparing it with the Total Return variant of an Index (TRI) of the benchmark index instead of the Price Return variant of an Index (PRI). While the PRI captures only the capital gains of the index constituents, the TRI additionally captures the interest and dividend payouts also.

In sum, investors wanting liquidity and are tax exempt or in the lowest tax brackets can opt for dividend payout; investors wanting to set off capital gains or losses against other losses or gains can go for dividend reinvestment; and investors wanting wealth creation can choose the growth option and hold on for the long term to avoid short term capital gains tax.

This article was originally published in The Financial Express