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A matter of dividends

Should you opt for growth or dividends from a mutual fund?

Nitya Varadarajan        Print Edition: October 5, 2008

Since various types of mutual funds come with distinct investment objectives, as an investor, the onus is on you to opt for a fund whose objectives best match your own investment needs and gives you the kind of returns you want from your investment. But your decision to opt for either a dividend or growth scheme should be based on three crucial factors— investment horizon, market conditions and taxes.

Sridhar Vetapalem, Independent Financial Planner, Pune
Sridhar Vetapalem
If you are looking at an investment horizon of three years or more in an equity fund, then you should consider the growth option. This allows your investment to compound over a period of time, thus, improving your rate of returns.

As dividends from mutual funds are basically a portion of the corpus that is returned to you, they do not help create wealth over time (unless you reinvest the dividend elsewhere).

However, if you are investing for the short term, a dividend option is more tax-efficient—dividends of equity funds are tax-free in the hands of investors.

On the other hand, short-term capital gains are taxed at 15 per cent plus surcharge and cess, which works out to 17 per cent. In an ELSS (equity-linked savings scheme), since your investment is locked in for three years, you could opt for a dividend option only if you need the income.

 Reap the dividends

Ascertain the tax status of the fund before opting for dividends.

Fund type: Equity
Dividend: Tax-free
Capital gains: 15% plus surcharge on short-term gains

Fund type: Debt
Dividend: Tax-free for the investor, the MF pays the tax. Short-term capital gains as per income tax slab, but long-term capital gains are taxed at 11.33 per cent without indexation and 22.66 per cent with indexation

Fund type: Liquid Plus
Dividend: Tax-free Capital Gains: Short-term capital gains are taxed at 14 per cent. Long-term capital gains treatment as in debt

Also, dividends from equity funds are irregular. Fund houses may declare dividends depending on the market conditions; in a bull market, the frequency of dividend payouts may rise, while the reverse may happen in a bear market. Says Sridhar Vetapalem, an independent financial planner from Pune: “There are no certainties of dividends from a mutual fund. In bear markets, they may not pay any at all.”

Debt funds, however, are taxed at a different rate. The dividend is taxed at 14.12 per cent. The shortterm capital gains from a debt fund is taxed as per the regular income tax slabs for individuals while the long-term capital gains is taxed at 11.33 per cent without indexation or 22.66 per cent with indexation.

So, it’s tax-efficient for you to opt for the growth option if your investment horizon is over a year for a debt fund. Otherwise, you can go for the dividend option if the tax rate is less than your slab rate. Note that the fund house deducts the tax and then gives the dividend. Yet, some savvy investors think that dividends from equity funds are good in a heated bull market. A dividend option is a form of profitbooking in a mutual fund.

A dividend option gives you the discipline to book your profits. You can reinvest the dividends you receive in a liquid fund for a short term and, perhaps, re-enter when the markets cool down. Says Y.S. Suresh, Financial Advisor at Bajaj Capital: “Investors close to retirement must opt for dividends from an equity fund.”

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