Which is better; growth or dividend reinvestment option?

Mar 28, 2019 9:15 IST 1495 views

Mutual funds, be it equity or debt funds, offer you 3 broad plans; growth, dividend payout and dividend reinvestment plans. You can choose the plan based on which suits your needs the best. Each plan has its own implication in periodicity of returns, relevance for financial planning and tax efficiency. Let us look at the concepts

  1. Growth Plan: Growth plan of a mutual fund does not offer any payout. Profits made on the portfolio are necessarily ploughed back into the scheme. These growth plans are continuous compounders of your wealth.
  2. Dividend Payout Plan: In this plan, the fund declares dividends out of profits. A fund can pay dividends only out of profits and not out of capital. That is applicable to equity funds and to debt funds. The NAV of the dividend plan reduces to the extent of the dividends paid, which is why you will find the NAV of a dividend fund always lower than a growth plan.
  3. Dividend Reinvestment Plan: Let us start by understanding that this plan is not very popular and hence most funds do not offer this scheme at all. In a dividend plan, the dividends are paid out in cash to the unit holders. However, in the dividend reinvestment plan the mutual fund buys units to the extent of the dividend declared by the fund at the post-dividend NAV and credits units to the account.

 

 

Let us now look at a live illustration

In this table the 3 different plans of Premium Equity Fund have been compared in terms of their value and the number of units’ pre and post dividend.

Particulars

Growth Plan

Dividend

Payout Plan

Dividend Reinvestment Plan

Units Bought

5000 units

5000 units

5000 units

Date of Purchase

01-Jan-2017

01-Jan-2017

01-Jan-2017

Purchase NAV

Rs.10

Rs.10

Rs.10

Value of Purchase

Rs.50,000

Rs.50,000

Rs.50,000

 

 

 

 

NAV on 31st Dec 2017

Rs.14

Rs.14

Rs.14

Value of Investment

Rs.70,000

Rs.70,000

Rs.70,000

Dividend Declared

N.A.

Rs.2

Rs.2

Dividend Paid Out

N.A.

Rs.2

N.A.

Units issued in lieu of Dividends

N.A.

N.A.

833.3333

#

Post Dividend NAV

Rs.14

Rs.12

Rs.12

Post Dividend Units

5000 units

5000 units

5833.33 units

Post Dividend Value

Rs.70,000

Rs.60,000

Rs.70,000

# - Dividend of Rs.10,000 (5000x2) will entitle him to 833.3333 units. Rs.10,000 / NAV of Rs.12

 

Some key takeaways from the analysis of these 3 different plans..

  1. The number of units remains the same in case of the growth plan and the dividend payout plan. However, in case of the dividend plan the number of units increase due to fresh units allotted in lieu of dividends.
  2. The post dividend NAV will be the same in case of the dividend payout plan and the dividend reinvestment plan. The only difference between the two is that in one the dividends are paid out in cash and in the other the dividends are paid out in units of the fund.
  3. In value terms, the reinvestment plan is the same as the growth plan since in both the cases the dividends have been reinvested into the fund. It is just the method of reinvestment that has changed. With equity dividends now attracting dividend distribution tax (DDT) at 10%, the attractiveness of dividend reinvestments could reduce even further.

 

3 point agenda: Which plan should you prefer?

Here are some interesting pointers on how you should go about selecting your plan

  1. For long term financial planning, growth plans are the best. You automatically reinvest the money into the fund and the power of compounding really works in your favour. That suits your purpose too.
  2. What about the tax aspects. Let us look at equity funds. If you invest in growth funds then the short term capital gains will be taxed at 15% (held for less than 1 year). Long term capital gains (held for more than 1 year) will now be taxed at 10% without indexation to the extent your LTCG exceeds Rs.1 lakh in a fiscal year. In case of dividend funds, the dividends will be tax free in the hands of the investor but will attract DDT of 10%. This makes growth plans more attractive in terms of tax management.
  3. In case of debt fund growth plans, STCG (less than 3 years) will be taxed at the peak tax rate but LTCG will be taxed at the rate of 20% after indexation. The DDT on dividend payouts on debt funds is 25% plus surcharge and cess. You can rather opt for a systematic withdrawal plan (SWP), which is more tax efficient.

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