Every dividend from a fund correspondingly reduces the fund's net asset value as it represents an outflow from the fund.

I am 27-years old. I have invested in three mutual funds Franklin India Prima Fund, Franklin India Prima Plus and Fidelity Equity and opted for growth options in all three. What is the difference between growth and dividend options? Why should a fund's NAV fall when dividends are declared? Which option is most beneficial for a five-year term?

-- Anil Johnson

Bangalore

Every equity fund invests your money in a portfolio of stocks. It generates returns from any appreciation in the value of these stocks. The basic difference between the dividend and growth options of a mutual fund lies in the manner of distribution of these returns to a fund's investors.

In the growth option, the appreciation that the fund earns on its portfolio is retained with the fund and allowed to accumulate.

You could realise these gains by selling at the NAV. In the dividend option, this return is periodically distributed as dividend payouts. The fund decides when and how much to pay out as dividend.

Dividends declared by a mutual fund are quite different from the dividends you receive from shares or other fixed return instruments, in the sense that they do not in any way add to the returns that you earn from your investment. Every dividend from a fund directly reduces the fund's net asset value (NAV) to that extent, as it represents an outflow from the fund.

This is because the NAV represents the total current market value of the fund's portfolio, whether held in the form of stocks, bonds or cash.

To take a simple example, assume that an equity fund owns a portfolio that is worth Rs 12,000 at today's prices and has 1,000 units outstanding with investors.

Its NAV would be Rs 12 (Rs 12,000/1,000). As the fund has earned a profit of Rs 2,000 from an appreciation in the value of its shares for this year, it decides to distribute a 20 per cent dividend to its investors.

Investors who are in the dividend option of this fund will receive a dividend of Rs 2 per unit (Rs 2000/100) and will continue to hold units with an NAV of Rs 10 each. Investors who have opted for the growth option will not receive any payout; they will hold units with an NAV of Rs 12 each.

As the dividend option allows you to periodically cash in your profits from the fund, we believe that it is more suitable for investors

who have an investment horizon of five years or less

who are risk averse and would like to reduce the swings in the value of their portfolio

who would like to receive money from the fund on a periodic basis

However, as an equity fund can pay out dividends only when it has profits available from the stocks in its portfolio, you cannot count on an equity fund for a steady or a regular stream of dividends.

Please read our detailed story on Page 6 for suggestions on when an investor should opt for the dividend option and when he should go for the growth option of an equity fund.

(Queries may be e-mailed to mf@thehindu.co.in, or sent by post to Business Line, 859-860, Anna Salai, Chennai 600002.)

Aarati Krishnan

(This article was published in the Business Line print edition dated June 19, 2005)
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