Which one are you gonna go for?

The question most people ask when investing in mutual funds is: Is the growth option better or the dividend? And what is this dividend reinvestment option that butts in as well? Here’s explaining the options you have and which one to go for.

A fund declares dividends from the profits of the investments in its portfolio. In the growth option, this dividend is retained in the fund - your capital plus profits remain invested. When you opt for dividend payout, the dividend declared is paid out to you. Since you receive the profits in your hands, only your initial investment stays put. The dividend paid is taken out from the net asset value of the fund — since dividends are paid out of profits, which form a part of the NAV. Thus, to the extent dividend is paid, the fund’s NAV drops. This is why the growth and dividend options have different NAVs. In a dividend reinvestment, the dividend that is stripped from the NAV is ploughed back into the fund by buying new units. So while your NAV falls, the number of units you own rises. It is similar to the growth option in concept, but different in execution.

With equity funds, it is always best to go for growth or dividend reinvestment. For one, equity investments usually need a longer time frame to deliver superior returns and are not meant for short-term needs. Two, taking out profits frequently from equity funds robs you of the benefits of compounding which enhances returns over the long term.

Three, you need to find another avenue to invest the dividend received and run the risk of choosing a poorer option. You also need to be disciplined enough to reinvest the amount. You don’t want dividends added to your spending, instead of your savings kitty. Note that with ELSS funds, each time dividend is reinvested, it counts as a fresh investment and so is subject to lock-in periods as well. Go for the growth option in such funds.

Debt funds are subject to dividend distribution tax, payable by the scheme. The dividend is stripped from the NAV in addition to the taxes paid. Currently, debt funds are taxed at 25 per cent plus surcharge and cess, totalling 28.325 per cent.

Not only that, capital gain from debt funds is taxed too. Short-term gains attract tax at your slab.

Long-term gains are taxed at 20 per cent with indexation and 10 per cent without.

If you’re holding investments for more than a year, growth is the best option no matter which slab you are in. But if you are holding for less than a year, go for the dividend reinvestment option if you are in the 30 per cent tax bracket. Others can go for growth.

If you are in regular need of cash flows, either opt for dividend payout or, if you have built up enough investments already, systematic withdrawals while retaining the growth option.

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