Mutual fund (MF) schemes

To generate wealth for the long-term, growth plans can help you do this far better than dividend plans

Mutual fund (MF) schemes

When you invest in mutual fund (MF) schemes, you will, in most cases, be better off choosing its growth plan option over its dividend plan. Here’s why.

  • If your goal is to generate wealth for the long-term, growth plans can help you do this far better than dividend plans.

  • In growth plans, the gains made are re-invested into the scheme and so, your investment can potentially grow and compound automatically over the long-term.
  • On the other hand, in dividend plans, the gains made by the scheme may be paid to you as dividends. So, the gains do not get re-invested into the scheme, and compounding does not happen automatically.
  • Note that in MF schemes, dividends are paid only from the gains made on the investment. Essentially, money belonging to investors is returned to them.
  • So, the net asset value (NAV) of the dividend plan unit falls to the extent of the dividend declared.

Tax efficiency

  • Even if your goal is regular income receipts from your MF investments, dividend plans are not the way to go.
  • One, the dividends are not assured. A MF scheme can declare dividends only from its distributable surplus. There may be times when a scheme is going through a rough patch and might not have enough to distribute as dividends. Even if times are good, the fund house is under no obligation to declare dividends.
  • Next, dividend payouts by MF schemes fare poorly on the taxation test; and the investor bears the brunt.
  • Dividends on equity-oriented MFs are subject to dividend distribution tax (DDT) of 10%. Add surcharge (12%) and cess (4%), and the effective rate of DDT is about 11.65%
  • On non-equity oriented MF schemes, the DDT is 25%. Add surcharge (12%) and cess (4%), and the effective DDT rate is a mighty 29.12%.
  • If you plan to hold your equity fund for 12 months or less, the dividend plan is better than the growth plan since dividends will be taxed at a lower rate (10.4%) than the STCG (15.6%).
  • But if you plan to hold the equity fund for more than 12 months or longer periods — this is usually recommended — the growth plan will, in most cases, score over the dividend plan.