Most investors are aware of the three options available in mutual funds (MF), which are dividend payout, re-Investment, and growth. The use of these options varies with each investor. However, investors are not aware of dividend functionality, calculation, and tax implications. Let us attempt to understand these in details.
In this option, profits of mutual funds are distributed among the investors at various intervals referred to as dividends. MFs would pay these dividends only when they perform well. The decision to pay dividend solely vests with the fund manager. When MFs declare a dividend, the NAV falls by the exact same amount. For instance, if a fund’s NAV is Rs.15 and it declares dividend declared is Rs.2 per unit, its NAV falls to Rs.13. With the new regulations, fund managers can declare dividend from only the surplus account.
Dividend is a kind of periodic profit booking. Dividend is not an additional benefit, as it is paid from the profits generated by the scheme.
Tax implication: The dividends received through equity funds, balanced funds (funds with more than 65% in equity), and debt funds are tax-free at the hands of the investor.
Using this option: This option is usually meant for investors:
- Looking for some short-term returns
- Wanting to reduce their risk from the capital market, as fund managers usually pay dividends when the market is bullish, near its peak, or when the MFs are making sufficient profits
- Who do not track their investments and wish to withdraw partial amounts when the scheme earns a profit
- In Equity Linked Saving Schemes (ELSS), where money is parked for a three year lock-in period
In this option, dividend paid out is ploughed back into the mutual fund, which means that the investor adds more units in the mutual scheme from the dividend income declared at the existing NAV. The NAV of the fund does not change, it remains the same as in the dividend payout NAV.
Tax implication: For this option of dividend re-investment, the time period is calculated separately for each dividend reinvested.
Using this option: This option is used majorly to acquire more number of units whereas the returns in this option and growth are nearly the same. Moreover, there is the benefit of tax deduction on dividends reinvested. This applies only in case of ELSS schemes. The dividends reinvested would be considered as an additional investment under section 80C.
This option tends to provide investors with an appreciation in the long term. For instance, the price appreciation reflects on NAV. There are no payouts in the midst.
Tax implication: In the growth option, capital gains tax (CGT) is the important tax to consider. CGT refers to the tax charged on profits from the sale of units. If the investor:
- redeems the investment in less than 1 year he/she has to pay a short-term CGT at 15%
- redeems the investment after the completion of 1 year , the long-term CGT would be NIL.
Using this option:
- This option is meant for investors looking for long-term returns, as they are not interested in small payouts.
- This option is also meant for those investors who are bullish in the market or have a long-term objective for investment.
Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.