Should You Opt For The Growth, Or Dividend Payout Option?
A considerable amount of confusion abounds within the community of Mutual Fund investors, on the choice between the "Growth" and "Dividend Payout" options. To make matters worse, all too common fallacies such as "low NAV is cheaper" sometimes drives investors to the option that has the lower unit price, only to the detriment of their long term financial objectives. If you're looking to make an investment into Mutual Funds, and are not particularly sure about which option to choose, this should help.
There are two primary determinants of the correct choice of option. First, the type of fund at hand - is it equity oriented, or is it debt oriented. Second - your own objective from the investment - long term wealth creation for a financial goal, or a periodic income stream?
What about the NAV differential between the two options - should that have a bearing on your decision? The short answer is No - even if the Dividend Option of a fund is priced at Rs. 20 per unit, and the Growth Option at Rs 200, they will provide exactly the same point to point returns, as they have the same underlying portfolio. Don't be fooled into believing that the ownership of a larger number of units will somehow serve to boost your returns!
Equity Oriented Funds
Dividends from Equity Oriented Funds (defined as those funds that hold a minimum of 65% of their assets in listed Indian equities at all times) are tax free right off the bat, whereas capital gains are taxed at 15% before a holding period of 12 months. Any profits booked after a 12-month holding period are tax free as well. Two points need to be considered here: one, if you're investing into an equity fund via a SIP or a lump sum for a financial goal that's several years away, choosing the dividend option could severely hamper your wealth creation potential, as the compounding effect will get almost completely negated. Take the example of a fund with a two-decade plus track record - Franklin India Bluechip. The NAV of the Growth Option of the Fund is roughly 445 as on date, implying that Rs 10,000 invested in the NFO of the fund would have grown to Rs 445,500 as on date. The NAV of the Dividend Option, on the other hand, stands at around Rs. 45, implying that (periodic cash flows notwithstanding), the current value of Rs. 10,000 invested in this option would be a much less impressive Rs. 45,000 as on date. Money that becomes visible in your bank account has a very high probability of getting spent to fund shorter term "wants", therefore contributing little to your long-term wealth.
Two scenarios where the dividend option for equity oriented funds make sense are one, for ELSS investments with an intended holding period of 3-5 years, and two, for balanced funds where an investment is being made with income as one of the objectives. ICICI Prudential Balanced Advantage Fund, for instance, has an excellent track record of declaring dividends. Since it is, on paper, an equity oriented fund - the dividends will be tax free from day one.
If you're quite certain that you will not be requiring an income from your equity oriented fund for the next 12 months, skip the dividend option. You can always pull out moneys as and when you need, tax free, after a year.
Debt Oriented Funds
The case is different for debt oriented mutual funds, such as bond funds, income funds and MIP's (Monthly Income Plans). Since dividends originating from these funds are taxed at a hefty rate of 28.33% at source, it makes scant sense for anyone to opt for the dividend option here. SWP's (Systematic Withdrawal Plans) or just redeeming units as and when liquidity requirements arise, is a much more tax efficient method of creating an income stream from your debt fund. The basic structure of an MIP can be replicated in a far more tax efficient manner by artificially creating a portfolio with a 25:75 asset allocation in favour of debt funds. Till the time that there's a change in the way that dividends from debt funds are taxed, it makes sense to steer clear from the dividend payout option in their case.
