In a mutual fund, how is the growth option different from dividend option?

How is a fund’s growth option different from the dividend option? What is the difference in the returns for investors under the dividend payout, dividend reinvestment and cumulative (growth) options?

— Nagesh M Rayakar, Hubli

There is no difference in the returns earned by the three options. But the tax treatment of gains from various categories of mutual funds can make a difference to investors’ overall returns. Let us look at a hypothetical example where three people A, B, and C invest Rs 10,000 in the three different options of a new equity fund. The starting NAV of all three options is Rs 10.

As the table shows, the value of the investment in all three options remains identical. Only, in the dividend payout option, a part of the investment (Rs 2,000) comes back to the investor. People who want periodic income from investments should opt for this. Longterm investors could go in for the growth or dividend reinvestment options.

This example is true only for equity-oriented funds which have at least 65% of their portfolio invested in stocks. In case of other funds, the investors’ returns would vary across the three options.

That’s because while there is no tax on dividends received from a mutual fund, there is a dividend distribution tax (DDT) payable on the dividend in case of debt funds, MIPs and debt-oriented balanced funds. This DDT varies from 12.5% to 25% of the dividend and is deducted at source, thus reducing the earnings from dividend.

The DDT on debt-oriented balanced funds, MIPs and debt funds is 12.5% of the dividend amount. Investors B and C in the table would have earned Rs 250 less than investor A if all three had invested in an MIP, debt or debt-oriented balanced fund. In case of cash funds, DDT is higher at 25%, which would mean Rs 500 gone in taxes.

Since there is no way to avoid DDT, it is better if investors in funds other than equity-oriented schemes opt for the cumulative option and redeem units as and when they need cash. If the redemption is within a year, the gains are added to their income. If the holding period exceeds a year, they have to pay only 10% capital gains tax on the profit. It still works out less than the DDT.

If the investor’s income does not exceed the tax free limit, he won’t have to pay even the capital gains tax.

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