Sunday, January 8, 2012

Choosing Between Dividend & Growth Option

When buying a Mutual Fund, the question which several investors are faced with is 'Should I take the dividend payout option or should I select the growth option?' There are varying views to this question with different mutual fund agents giving various arguments in favour of one of these depending on their fund house marketing objectives. Here is a look at which one would make sense for a retail investor looking at investing money in a mutual fund.

Before I compare the types, here is a quick look at various options available in the market:

1.Dividend payout option - This option proposes to timely pay distributable surplus / profits to you in the form of dividends (either through cheques or ECS (Electronic Clearing Service) credits), thereby facilitating you to liquidate profits.

2. Dividend re-investment option - Under this option instead of paying dividend cheques or providing ECS credits, the dividend amount declared by a mutual fund scheme, goes in buying additional units of the same scheme (where you are invested), and you continue to book profits and keeps re-investing them in the same scheme.

3. Growth option - Under this option, you do not receive any dividends. Instead continue to enjoy compounded growth in value of your mutual fund scheme, subject to the investment bets taken by the fund manager.

4. Bonus option - Under bonus option you are not paid regular dividends. Instead you continue to receive bonus units in accordance to a ratio declared by the fund house. (very few mutual fund houses have this option)

Now what is a better option? A Dividend payout option or a Growth one? The answer to this question depends totally on your financial plan and objectives. The factors which determine the answer are your age, income, expenses, nearness to goals and risk appetite. If you are young, your income is higher, your commitment towards certain expenses are lower, your willingness to take risk is high and you are many years away from your financial goals; then you may opt in for the growth option (while investing in mutual funds). And remember at a young age, since one generally doesn't look for a regular cash flow (as generally a regular income flows in the form of earnings), one should ideally opt in for the growth option. However despite the financial planning aspects stated and the regular income earned, if you are still looking for a cash flow (in the form of dividend) or want to book partial profits at regular intervals, then you may consider the dividend payout option while investing in mutual funds.

If you look purely at the returns from the two options, over the long term (period of over 5 years), the growth option gives a higher compounded rate of return. Another important point to note is that SEBI has proposed norms which bar mutual fund houses from tapping the unit premium reserve account and instead declare dividends from realized gains (i.e. profits booked in the event of upswing in the markets); the quantum of dividends is expected to reduce. In fact at present some mutual fund houses have even held back their plans of declaring hefty dividends (as seen in the past).

Conclusion: Remember, while your agent / relationship manager may give you the dividend track record of a mutual scheme and try to paint a very rosy picture, it may not carry much relevance now (in context of the new norms proposed for dividend declaration). Hence while selecting between the dividend option and growth option, see what suits your financial plan / needs primarily. If you are looking at the benefits of compounding then you should ideally opt in for the growth option. Whereas, if you are looking at regular cash flows (in the form of dividends) or want to book profits at regular intervals, then you may consider the dividend (payout) option while investing in mutual funds.

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