Once the investor finalises the mutual fund scheme in which he would invest, he has to choose between the growth option and dividend option of the fund. . From investment point of view, it becomes very imperative to understand the implication of the option you are choosing.
When investing in a bond or a deposit, an investor gets regular income but no appreciation in the investment value. In equity, there is the possibility of appreciation but there’s no regular income. Mutual funds enable the best of both worlds. Investors can buy a debt fund and choose a growth option, thus opting for capital appreciation in a debt portfolio. Investors can buy an equity funds and choose a dividend option, to get regular income.
The dividend option pays periodic dividends to the investor provided the fund has earned returns. The dividend payment may be either ad‐hoc or at regular intervals. The growth option provides long‐term capital appreciation which can be realized at any time the investor chooses. Consider for example an investment of Rs.50 in a fund. Assume that the NAV has moved up to Rs.60 over time. The fund may declare Rs.10 as dividend and pay out the realised appreciation in a dividend option. In the growth option, the investor can sell off the units at Rs.60, and realize the growth in NAV.
An investor should consider the tax implication on both the options. Taxation on growth funds is simple, as only capital gains are calculated, and for equity funds there is no tax on long term capital gains (holding period greater than a year), while for short term capital gains (less than a year), it is 10%. In the case of debt funds in the growth option, short term capital gains is taxed at 30% whereas Long term(more than three years), capital gains is taxed at 10% without indexation or 20% with indexation. However, in the case of dividend options, the dividend is tax free in the hands of the investor, but the fund will have to pay dividend distribution tax before it gives the dividend.
Each type of option has its advantages and disadvantages, and deciding which is a better fit will depend on the needs and circumstances of the investor.