Once an investor has made up her mind to invest in mutual funds a journey of sometimes slightly confusing proportions starts. Where should one invest in? The growth option or the dividend option. Should one opt for a bonus plan or chose a systematic investment plan. We take a look at all these different options and why you should chose one option over the other.
Each of these and other options available aims to provide certain benefits or advantages. The growth option provides you an option to keep money invested over the course of your stay with the fund. While this may seem pretty straightforward there can be complications here. If the market rises over a period of time and then falls and if you do not book the gains, much of your profits could be lost. In this scenario the dividend option seems better. One might as well as receive a part of ones gains as dividends. However, in a steadily rising market it seems better to stay invested rather than take dividends and reduce the overall returns. As no one can consistently make a correct call on markets this option is also hazardous. So it seems that it better to view these options in terms of ones financial requirements. If growth of investments is sought, the growth option is the logical choice. Some income along with capital appreciation propels one to the dividend option. In equity linked saving schemes if a part of the returns can be obtained within the lock in period then, this is a clear advantage over other tax saving instruments. The dividend option can confer a degree of liquidity here.
However, if you feel that dividends offered by funds seem to be a free lunch, beware! Entering a fund just before the dividend declaration to obtain these dividends can get you nowhere. In such cases dividends come out of your capital leaving you no better off than before. If you have not been invested for a sufficient time so that your investment has generated a return, you do not get the profits. A similar situation arises when funds declare a bonus.
However, the results can be the same even when there is no intent to invest just for receiving dividends. A fund with an NAV much above par is a reflection of its ability to give dividends. If you have invested in such a scheme and its NAV has come down considerably, but is still above par, you may be in trouble. If the fund decides to declare dividends then you will get the dividends out of your capital. As your investment has not managed to generate a positive return you do not benefit from the dividend declaration. While this situation may make one unhappy it cannot be denied that it is fair to all concerned. For each according to his ability seems to be the motto here. The different options in mutual funds also have different tax implications. Thus the growth option is generally the most tax inefficient. Long term capital gains are taxed at the rate of 20 per cent with indexation or 10 per cent without, whichever of the two is lower. As compared to this short term gains are taxed at the marginal rate of tax.
In the case of dividends the tax treatment has changed with this years budget. Dividends from all mutual fund schemes are now tax free in the hands of investors. Debt schemes will, however, have to pay a dividend distribution tax of 12.5 per cent. Equity schemes will be exempted from this dividend distribution tax for the next one year. In the case of equity funds, the dividend option becomes the most tax efficient one. In the case of debt schemes the systematic withdrawal plan of the growth option remains the most tax efficient withdrawal mechanism. The method of receiving returns thus becomes very important as taxes can eat away a substantial chunk of returns.