Every mutual fund scheme comes in two types of plans – growth and dividend. The growth option gives returns in the form of rising values of mutual fund units. Whereas, under the dividend option returns are paid via periodic dividends.
Types of Mutual Fund Dividend Plans
The dividend plan of a mutual fund scheme is available in different varieties namely dividend payout, dividend reinvestment and dividend sweep. Under the dividend payout plan, the dividend declared is paid into your bank account. Whereas, the dividend reinvestment plan reinvests the dividend in the same fund that has declared the dividend and the dividend sweep plan invests the dividend in units of another mutual fund of the same fund house.
Are Mutual Fund Dividends Same As Stock Dividends?
Mutual Fund and stock dividends are two different things. While stock dividends represent profits earned by a company, mutual fund dividends are not an indicator of the profitability of a mutual fund scheme. High mutual fund dividends do not mean that the fund is doing very well or otherwise. When a mutual fund scheme declares a dividend, the NAV (Net Asset Value) of the concerned scheme falls by a corresponding amount. For example, if a mutual fund with a NAV of Rs 20 declares a dividend of Rs. 2 per unit, the NAV of the scheme will fall to Rs. 18 per unit.
Hence, an investor should not invest in a mutual fund just because it pays high dividends and should think which plan of the scheme suits him/her more – growth or dividend.
When Are Mutual Fund Dividends Declared?
The right to decide the timing of declaration of dividend completely rests with a fund house. An investor has no say in it. However, an investor can control, when does he/she want to sell his/her mutual fund units and realise the involved capital gains, if any.
Tax Treatment – Growth vs Dividend Mutual Fund Plan
The growth and dividend plans of a mutual fund are taxed in the following manner:
Dividends of equity mutual funds attract dividend distribution tax at 10%. This is slightly less than the short-term gains tax which growth mutual funds attract at 15% (for holding periods less than 1 year). However it is the same as the long-term capital gains tax which growth mutual fund attract at 10%.
Dividends of debt mutual funds attract dividend distribution tax at 25% along with surcharge and cess which makes the total DDT reach nearly 29%. This is very close to the highest slab rate for income tax in India at 30%. In case of the growth option, the short term capital gains on non-equity funds (including debt funds) is paid as per the income tax slab rate. Hence if you are a 30% slab investor, you will pay almost the same tax on growth and dividend options. However, if you are a 10% or 20% slab investor, you will pay a lower tax on growth options of mutual funds. In case of long term capital gains tax on non-equity mutual funds, you pay 20% after indexation, regardless of your income tax slab. This is substantially lower than dividend distribution tax at 29%.
The criteria deciding which is a better plan better plan between growth and dividend varies from investor to investor depending upon his/her investment object. However, on a general note, the growth option of mutual funds is better than the dividend option. The following are the reasons which make the growth option a better choice:
- Mutual fund dividends do not give an insight of the scheme’s performance as they are not an indicator of the profitability.
- Mutual fund dividends do not create value, they only distribute value. Thus, there is no wealth creation and appreciation under the dividend option.
- An investor has no say regarding the timing of declaration of mutual fund dividends.
Mutual fund dividends attract higher tax rates than capital gains involved in the growth option of the mutual fund schemes in most scenarios.