Selecting a mutual fund is not an easy task. Even after deciding on the company and the fund, there are still other issues, such as the type of the fund (growth or dividend), that need to be sorted out. To make things more complicated, the dividend option is bifurcated into dividend reinvestment and dividend payout schemes. The fund agent’s explanations may not help much in understanding how these work. Here are some points you need to know.
Dividend or growth
While a growth option ploughs back all the profits made by your fund into the scheme, a dividend option allows you to either get dividends from time to time or purchase additional units with that money. When dividends are paid out to investors, the net asset value (NAV), or the price of a unit, will fall to the extent of the dividend payout.
Dividend reinvestment and dividend payout
As the name suggests, dividend payout options pay dividends to investors from time to time. A lot of investors, however, get confused between dividend reinvestment and growth options since both put the gains back in your schemes.
The difference between the two lies in their way of investment. While the growth option increases NAV over a period of time, under dividend reinvestment option, dividends declared by the fund are reinvested on behalf of the investor, thus increasing the number of units held by the investor.
The decision about a fund type also depends on what kind of an investor you are—long term or short term. For short-term investors, who invest for less than a year, dividend is a better option because you can save short-term capital gains tax of 10% on your dividend income as it is not taxed (however, the fund house will have to make a dividend distribution tax, reducing the NAV to the extent of the tax paid). Capital gains or losses arise when you sell an asset, such as a house, mutual fund or shares, and make a profit or loss on it.
If you own a debt fund and your income falls under the lowest tax slab, for short-term gain, it is advisable to take the growth option since the impact from tax will not be high. But, if you fall in the higher tax slab, dividend is a better option; otherwise your gains will be clubbed with your total income and get taxed at higher rates.