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Mutual Funds are an essential component of an investment portfolio. Once you have made your decision to invest in mutual funds, your next step would be to decide the type of funds you want to put your money in. To decide the type of fund that is right for you, you need to be clear about your objective — do you want a regular income from your investment or are you primarily looking for capital appreciation over the long term?
Mutual funds can be categorized into two:
1. Growth Funds
2. Dividend Funds (including Dividend Re investment funds)
Mutual fund — Growth option
As the name suggests, growth funds aim at capital appreciation or increase in the Net Asset Value (NAV) for the investors. So, if you want to invest for long-term capital appreciation of the investment value and do not expect immediate returns, you should invest in growth funds.
The fund house does not distribute any profit generated on the funds. The profits are reflected as growth in the NAV of the fund units. If the fund makes profits, the NAV rises and vice versa. Actual income is generated from the funds only when the investor sells some or all units of the fund.
Similar to shares, there is no long-term capital gain tax on profits made from the sale of units of the fund. A short-term capital gains tax of 15 per cent is levied on short-term profits (i.e., profits on sale of units within a year of purchase).
Growth funds are good for young investors who have a regular salary income or other sources of regular income. Growth funds provide an opportunity of increasing wealth in the long run. NAVs of growth funds are much higher than the even fund with dividend option.
Mutual fund — Dividend option
If your objective of investment is generating a regular income, the dividend option is suitable for you. Asset allocations and risk factors for funds with the dividend option is the same as growth funds. In fact, the fund is the same at its core. Growth and dividend options are basically different methods of distributing profits to investors.
Under the dividend option, the fund house distributes a portion of its profits regularly to investors. For example, if a fund makes a profits of Rs 10 per unit and declares a dividend of Rs 5 per unit, the investor gets a dividend of Rs 5 per unit and a capital appreciation (increase in NAV) by Rs 5 per unit.
Hence, under this option, the investor gets a regular income as well as slight capital appreciation. NAVs of dividend option funds are generally lower than the growth funds.
Mutual funds do not guarantee income/profits; hence, whether the fund is able to make regular payments to investors depends upon whether it is able to generate profits. In case the fund makes losses, the investor will not get any dividend in that period and also suffer loss of NAV.
The investor does not have to pay any income tax on the amount of dividend received. However, the fund houses are required to pay 13.84% dividend distribution tax before distributing dividend. This, in turn reduces, the NAV of fund units.
For example, for a dividend of Rs 30 lakh, a fund house is required to pay Rs 4.15 lakh towards tax.
Note the equity funds do not have to pay dividend distribution tax.
Dividend option for regular income
The dividend option is good for investors who prefer a regular income. People nearing their retirement can think of this option. Even women who plan to take a break from work can think of this option to generate a regular income when they are not employed.
The dividend option is also good when the economy is hot and the NAV is increasing. So, the investors get realized profits by means of dividends and in the eventuality of market prices falling, the investor has made some profits contrary to growth funds, where the investor loses NAV and has no realized profits.
A variant of the dividend option is the dividend reinvestment option. Here the dividend declared is used to purchase more units of the same fund at the current rates. Hence, the investor gets dividend in the form of additional units of the fund.
From The Economic Time