Growth Or Dividend Payout Or Dividend Reinvestment? Which Is Better?
A) Growth option simply implies that the profits, along with your capital, stay invested in stocks/debt to earn you more money. No portion of capital or profit is withdrawn or shared until redeemed , thereby the entire amount keeps on making more money.This type of investment is more suited for long term investing in equity mutual funds, as there are no taxes on long term capital gains. Also, equity mutual funds are prone to short term risk, but in the long term they typically give good returns. This option benefits from the power of compounding since not only is the principal invested, but also the notional profit. It is a good option for those who do not need to depend on a monthly income from their investments for their living.
B) Dividend Payout means, a portion out of the profits is being booked & shared with investors in form of dividend post payment of dividend distribution tax at Fund level for debt fund (DDT is not applicable for equity funds.). It implies that a part of such profits is stripped from your NAV and given to you. Hence, your NAV falls to the extent of dividends.This option is ideal for short term investments, especially in debt. Debt mutual funds with dividend options are a good option for senior citizens who require a steady income flow and not only capital appreciation.This option will give the investor the benefit of moderate capital appreciation along with dividend returns over the period of holding. It is important to note that due to the payouts, the power of compounding is not as efficient as compared to that of the growth option.
C) Dividend Reinvestment option too, profits are stripped. This option tries to make the best of both worlds, in the form of declaring dividends to investors, but not issuing the dividends in the form of cash but re-investing the dividends into the same mutual fund for additional units.But instead of sharing the same with investors, this money/surplus is used for purchasing additional units which in turn are allotted to investors as units at the prevailing NAV. Hence, indirectly, by adding more units, you simply stay invested in the fund.
Factors Governing the Choice of Options:
- Cash Flow Requirement – If you doesn’t require regular cash inflow (money back) from your investment and if you are looking at long term investments then growth option is best for you because your investments gets compounded .But if you require regular money inflow every year from investments for some purpose, it may happen that you have more responsibilities and more dependents and if any small money which you get extra every year is helpful to you (like post retirement period), in that case you can go for dividend option.
- Taxation – Taxation on Equity funds is simple, as only capital gains are calculated, and for equity funds there is no tax on long term capital gains, while for short term capital gains it is 15%. In the case of debt funds in the growth option, short term capital gains is taxed as per slab whereas Long term capital gains is taxed at 20% with indexation. However, in the case of dividend options, the dividend is tax free in the hands of the investor, but the fund will have to pay dividend distribution tax before it gives the dividend.
An Individual can opt for an option based on above factors. In general , you can invest in growth or dividend re-investment options for long term wealth creation while you invest in the dividend payout option for regular income. There is little difference between growth and dividend re-investment for equity funds (long term). In debt funds, choice between growth and dividend re-investment shall be driven by tax considerations.