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 held mutual fund units. Whereas, under the dividend option, returns are paid via periodic dividends.
Mutual Fund and stock dividends are two different things. While stock dividends represent the 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 30 declares a dividend of Rs. 2 per unit, the NAV of the scheme will fall to Rs. 28 per unit.
Hence, an investor should not invest in a mutual fund just because it pays high dividends and should think as to which plan of the scheme suits him/her more – growth or dividend
Tax treatment plays an important role while selecting Growth or Dividend 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 funds 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 growth option, the short-term capital gains on non-equity funds (including debt funds) are 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 to decide which is a better plan between growth and dividend varies from investor to investor depending upon his/her investment objective.
However, on a general note, the growth option of mutual funds is better than the dividend option.
The following are the reasons as to why growth option a better choice: