After years of hard work while finishing his management studies, Mohan finally started working with a well known multinational. Coming from a lower middle class family, Mohan had witnessed the financial hardships his parents had to go through for his education and other daily financial requirements. Now with a good income as a starting point, Mohan wanted to embrace the advantage of early investing in order to build a good financial corpus for his future. Like a lot of first time investors Mohan decided to invest in mutual funds using a systematic investment plan (SIP) which would allow him the benefit of investing small amounts each month. Sure about his investment goals, Mohan decided to shortlist the mutual funds he thought were a good for investing. But he found it confusing as the shortlisted mutual funds had two options of growth and dividend scheme with different net asset values. How can a same mutual fund have different net asset values and which one would be a better bet for his investment goal?
Confused, Mohan decided to take help of a financial advisor to understand the difference between types of mutual fund schemes and their pros and cons.
An overview of Growth Option:
All investment made undergrowth this option mean that the Net Asset Value or NAV remain constant as they were at the time of buying the fund. The value of NAV however changes according to the performance of the fund over the years. The rise in NAV value of the mutual funds gives the investor capital appreciation and returns when selling the NAV units of the fund. Growth fund options are more suitable for people having a long term investment perspective. Since there are no taxes on long term capital gains and mutual funds typically give good returns over a long tenure, growth fund options are a good idea. On the downside however people investing in growth option mutual funds do not get a short term income or dividend.
An overview of Dividend Option:
Dividend option as the name suggests offers regular income for the investors as it repays a part of the investment each year. The repaid amount is known as dividend which is declared per unit basis for the fund. A common misunderstanding a lot of people have is that they feel a dividend is over and above their invested money. The fact is that dividend is a part of the investment made by the investor.
For example let us suppose an investor holds 1000 units of a mutual fund and the fund declares a divided of Rs 5 per unit. The Investor would hence receive Rs. 500 as dividend but the net asset value or the NAV is offset proportionately. Dividend option funds also offer users an option of dividend reinvestment plan where the dividend paid pout is used to purchase new units of the same mutual fund leading to an increase in the number of units of the fund over time. The investor however faces the risk of having to pay an entry load each time a dividend is reinvested in case the mutual fund offer document subjects to an entry load mid tenure.
So which one should you opt for?
Like a lot of investment instruments there is no clear black and white when it comes to choosing between growth option funds or dividend options funds. Both have their place in the financial structure and the investor must choose the right fund as per his or her financial goal. For example in case of Mohan, since he is looking to create a future financial corpus, opting for a growth option fund is more suitable. Since Mohan is working and gets a monthly salary the advantage of getting any dividend paid out each year would suffice no real purpose. The rise of NAV of the units for growth option funds can be redeemed at a premium in the future allowing Mohan to get maximum value for money for his investments.
Taxation Impact:
Taxation structure must be taken into account while choosing either the growth option or the dividend option. Taxation on growth funds depends on the type of fund. In case of equity fund any profit on sale of fund units within one year of holding would result in short term capital gain tax which is taxed at 10%. Any profits earned by selling the units after one year holding period also known as long term capital gain is tax free for the investor. On the other hand, the dividend paid out by mutual fund companies is also tax free in the hands of the investor. The mutual fund however needs to pay dividend distribution tax before it giving out the dividend to its investors.