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Should You Opt For Dividend Option In Mutual Funds

By Author: Shashank Pawar
Total Articles: 31

The choice of investing in a growth option versus a dividend option depends on what your financial goal is. Growth option is suitable for investors looking for long-term growth while dividend option is suitable for those looking for an additional source of regular income.

Mutual funds provide a lot of flexibility to investors in terms of features like regular and direct plans . Those who wish to invest in mutual funds directly and save on the commission cost being paid to mutual fund distributors by the fund house can invest in the Direct Plan of the fund and experience a lower expense ratio. Those investors who are not well versed with mutual funds or do not have the time to manage their investments can go for Regular Plans. Within the plans, investors again have the choice to go for growth option or dividend option. Those with wealth creation over the long-term as part of their financial goals should opt for growth option while those who seek regular income should invest in Dividend option of a mutual fund scheme.

As you would be aware mutual funds invest in a basket of securities like stocks, bonds, gold and international securities. The securities in which a mutual fund invests the pooled money of its investors make up the portfolio of the fund. The mutual fund ends up buying and selling securities in its portfolio on a regular basis to ensure the fund performance remains on track. During this portfolio rebalancing process, the mutual fund scheme may make some profit and as per SEBI mandate, a fund can declare dividends only from the gain it makes from the sale of securities held in its portfolio or from current income received in the form of interest or dividends from securities held in its portfolio. Thus, mutual fund dividends are paid out of the distributable surplus or profit made by selling securities held in the portfolio of the schemes. Mutual fund schemes also hold dividend paying stocks or interest-bearing fixed income securities as part of their portfolio. When these underlying securities pay dividend or interest, the scheme is required to pass on all such payments to its investors.

Since an investor seeking wealth creation does not need interim payments from the fund in the form of dividends, it is advisable for such investors to invest in growth option where the distributable surplus is added to the assets of the fund and the investor can experience a higher NAV over time. Such investors get to experience the compounding effect of this distributable surplus being retained in the fund for further investments.

An investor seeking regular income would benefit from investing in the dividend option of a scheme as he can expect to earn some dividend income on a regular basis. But a word of caution for such investors is that if markets fall and the scheme makes losses during such a bear phase, the fund may not distribute any dividend. Hence such investors should also have other savings and investments as a backup.

While dividends are not taxable in the hands of investors, the fund must pay a Dividend Distribution Tax on dividend being distributed. This reduces the net distributable surplus of the fund while the regular option investor continues to benefit from the compounding effect of the surplus contributing to a higher NAV of the scheme.

If you are looking to invest in mutual funds and would like to familiarize yourself with the various aspects of mutual fund investing, do visit Mutual Funds Sahi Hai, investor education initiative by AMFI (Association of Mutual Funds in India).

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