Confused over Growth, Dividend pay-out, Dividend Reinvestment or bonus option in Mutual Funds

Mutual Funds | admin | October 2, 2010 at 1:54 pm

Rajeev Mehra (name changed) a young IT professional has identified the mutual fund scheme that he wishes to invest in.

However, while filling in his investment application, he is perplexed with the various investment options available viz. growth, dividend pay-out, dividend reinvestment and bonus.

Despite being aware of what these options meant, he could not decide which was most suitable for him.

Irrespective of the scheme option chosen, the gains that you receive (excluding the tax implications) would be identical across all. Therefore, you should keep in mind your investment horizon and tax liabilities, while choosing the scheme that is most suitable for you.

Taher Badshah – Sr. Vice-President & Co-Head of Equities, Motilal Oswal Asset Management Co. Ltd., echoes a similar thought, “The scheme option such as dividend, growth or dividend reinvestment will essentially be a function of the investor’s requirement for periodic returns or cash flows – which in turn will be a function of his or her investment horizon.”

Here are some situational thumb rules you could use:

Equity oriented mutual fund scheme

Case 1: Investment term less than 12 months

If you wish to generate regular income, the best option would be the dividend pay-out option. However, if a regular income is not required, dividend reinvestment is a better option. Moreover, the dividends declared are exempt from Dividend Distribution Tax* (DDT) and are also tax-free in the hands of an investor.

Case 2: Investment term greater than 12 months

The growth option, in this case, will enable the investment to benefit from the effect of compounding.

Debt oriented mutual fund scheme

Case 3: Investment term less than 12 months

If you are a tax payer and fall in the 10 per cent tax slab, you could choose the growth option or the bonus option as your returns will not attract DDT* while the capital gains tax that you pay will be at the rate of 10 per cent.

However, if you fall into a higher tax slab, then, it would make more sense to opt for the dividend pay-out or reinvestment option, which will save you more on the capital gains tax even after factoring in the DDT in most cases.

Case 4: Investment term greater than 12 months

It would be advisable to choose the growth or bonus option in this case because the long term capital gains tax liability is calculated at the rate of 10 per cent, without indexation, or 20 per cent with indexation, whichever is lower and the DDT is not applicable.

Note: DDT rates applicable in case of individuals is 27.68 per cent, in case of money market or liquid funds and 13.84 per cent in case of other debt funds. All tax laws are for the financial year 2010-11.

Source: Economic Times