Dividend or Growth: Which MF option is better for you?

Dividend or Growth: Which MF option is better for you?

While dividend option on debt fund works for those looking for regular income, all other investors should invest in growth option.

When Shweta first met her financial advisor, the idea of a mutual fund really appealed to her. She was really delighted that she could create wealth through equities and also get the benefit of diversifying her risk. But she was really spoilt for choice. There were over 35 fund houses and over 1000 schemes on offer. Further each scheme had a direct plan and a broker plan. Then you could choose between a growth option, dividend option and a dividend reinvestment option.

Her financial advisor had guided her on the method of choosing the fund house and how to do due diligence on the fund before investing. Her big challenge was should she opt for a dividend scheme or for a growth scheme.

Shweta was impressed by the fact that in a dividend scheme she will be earning tax-free income. She has considered five broad factors for choosing whether she must opt for a dividend option or a growth option.

Factor 1 – Which option is better for long term wealth creation? The reason Shweta decided to start off with equity mutual funds was to build wealth over the long run. In a dividend plan, each time the dividend is declared, your dividend is paid out of your wealth created in mutual funds. To that extent it reduces your long term wealth. Consider the example of XYZ equity fund which had an NAV of Rs.10 when it was launched in 2010. At the end of five years, the NAV of the growth option stood at Rs.45, while the NAV of the dividend option stood at Rs.19. The remaining Rs.26 had been paid back by the fund as dividends. The problem you will face is that these dividend receipts tend to be used for your expenses. Unless these dividends can be reinvested at the rate of return that your fund is earning, the growth option will always be a better wealth creator over the long run.

Factor 2 – How important is the tax saving argument for dividends? Theoretically, there is an argument that a dividend option is better as the dividends are tax free in the hands of the unit holder. But then you are in the mutual fund for the long haul as you can earn attractive returns on equity mutual funds only if you hold for a period of over five years. In case of capital gains, long term is defined as one year. Thus any sale of mutual funds after one year results in long term capital gains and do not attract any tax. Thus for a long term investor the tax-free dividend argument does not hold much water.

Factor 3 – Are you using the mutual fund to meet specific life goals? The best way to handle your mutual fund portfolio is to earmark specific portfolios for specific needs. For example you need to plan for paying the margin money on your car, the margin money on your house or for taking a foreign vacation in the short term. In the distant future you need to plan for your child’s education, their marriage, your retirement etc. When you have earmarked specific funds for specific needs it is always advisable to opt for a growth option. This growth option will give you the best benefits of compounding over a long term as the reinvestment of returns will happen automatically.

Factor 4 – Do you have regular liquidity requirements? This is an important factor determining whether you must opt for a growth option or a dividend plan. While dividends on equity funds can be erratic based on performance, dividends on debt funds are more regular and predictable. In case you are looking at getting regular incomes through investment in debt funds, you can go for a dividend option. Unlike in case of equity funds, debt funds are not used for long term wealth creation but more for safety or principal and assured income streams. Since the holding period for capital gains treatment is 3 years in case of debt funds, one can opt for a dividend scheme, especially if one is looking at regular income from the mutual fund investment.

Factor 5 – Do you intend to take loan against mutual fund units. Today, most banks and finance companies offer you loans against mutual fund units. Normally, in case of equity funds you can get loan against mutual fund units with a 50% haircut of the NAV value of your mutual fund holdings. In case of a growth plan, you will automatically get a higher Loan to Value (LTV) and that will be beneficial for you in getting higher leverage eligibility. This can also be a consideration to opt for growth plans of mutual funds.

There are no hard and fast rules on growth versus dividend option. However, these ideas can help you crystallize your choice better...

• If you are looking at regular tax-free income, prefer a dividend option

• If you are looking to create wealth over the long run then opt for growth option

• If your mutual funds are meant for specific long term needs, stick to the growth option

• In case you want to leverage your mutual fund holdings, prefer a growth plan



As a general rule, a growth plan is preferred as mutual funds are instruments to create wealth over the long term. Growth options follow the classical theory of compounding. The more you invest, the more you earn! The more your reinvest what you earn, the more wealth you create.

Happy Investing

Source:moneycontrol.com