What is difference between growth fund and dividend fund?
Equity funds usually offer three options for investors to choose
from - the Dividend Payout option, the Dividend Re-investment
option and the Growth option. A few funds have also started to
offer a Bonus option. These options differ only in their method of
distribution of returns. When you choose the dividend option, you
get to partially cash in on the returns earned by the fund from
time to time, through the dividends it declares. When you choose
the growth option, the returns earned by the fund are retained and
reflect as an appreciation in the fund's Net Asset Value (NAV).
Please note that the dividend does not in any way, add to your
returns from the fund. The Dividend Re-investment option authorises
the fund to plough back the dividends declared into the fund at the
prevailing NAV, fetching you more units. In terms of its effect on
your returns from the fund, the Dividend Re-investment option is no
different from the Growth option. The Dividend Re-investment option
is the superior option for investors who want the tax efficiency of
the dividend option and are also willing to remain invested in
equities through its ups and downs. If they need liquidity, such
investors can liquidate a part of their holdings at NAV. To
illustrate how these options work, let us suppose you invested
Rs.1000 in a fund at an NAV of Rs.10 per unit, fetching you 100
units. Six months later, because of an appreciation in the fund's
portfolio, the value of the units you hold has grown to Rs 1,200.
In the Dividend option, the fund may declare a dividend of Rs 2 per
unit and pay out Rs 200. The value of your residual holdings in the
fund would be Rs 1000. In the Growth Option, you would not receive
any payout, but the value of your holdings would be Rs 1,200 at the
end of six months, as the value of the100 units you hold would have
grown from Rs 10 to Rs 12 per unit. In the Dividend Re-investment
option, the Rs 200 declared as dividends would be reinvested in the
fund at the prevailing ex-dividend NAV, and you would be left with
120 units worth Rs.10 each. Your investment value at Rs 1,200,
would be the same as in the Growth option. The Dividend option
(whether Reinvestment or Payout) is the more tax- efficient way of
receiving your returns from an equity fund. The dividends declared
by an equity fund (funds with over 50 per cent equity exposure) are
exempt from distribution tax and are also tax-free in the hands of
an investor. But any returns that you earn on the fund by way of
appreciation in NAV, is subject to capital gains tax. Capital gains
are taxed at 10 per cent if you hold the fund for less than a year;
but are exempt if you hold for over one year. In the above example,
if you opted for Dividend Payout, you would have no tax liability
at the end of the six-month period. The same would hold good of the
Dividend Re-investment option. However, if you sell your units in
the Growth option at the end of the six-month period, you would
have to pay short term capital gains tax of 10 per cent on the
Rs.200 you earned by way of appreciation on the Growth Option NAV.
Tax reasons apart, choosing the Dividend Option may also confer
other advantages for conservative investors. Equity funds declare
dividends only from the profits booked on the holdings in their
portfolio. They have tended to pay out liberal dividends when the
stock markets are in a buoyant phase and refrain from payouts when
the markets are in a bearish phase. Dividend payouts thus offer you
the opportunity to cash in partially on any returns that the fund
has made, after a sharp run-up in stock prices. Dividend payouts
also help you re-balance your equity holdings when the markets are
buoyant, guarding you to an extent against a decline in values. The
flip side in opting for the Dividend Option is that they could
result in an opportunity loss in a rising market. In the above
example, if the NAV of the fund climbed from Rs 12 to Rs 15 per
unit after the dividend declaration, investors who opted for
Dividend Payout would have suffered an opportunity loss on the Rs
200 that they have pulled out of the fund by way of dividend. Their
appreciation would be restricted to the Rs 1,000 they have invested
in the fund. In contrast, investors who have opted for the Growth
and Dividend Re-investment option would have earned an appreciation
on the entire sum of Rs 1,200 that they retained in the fund.
Rafa
Ezra
Judy
