Some days back we wrote about tax saving instruments eligible for deduction under section 80C. We presume that most of the risk taking individuals will and should prefer ELSS for investing for saving tax. This gives dual advantage of tax saving and at the same time keeping the returns linked to equity indices. While investing in various funds, investors come across two categories Growth option and dividend option, generally denoted with letters G or D after the name of the fund. The selection between the two can be an important step towards building wealth or building a stream of regular income. The purpose of this article is to guide you in making the appropriate selection.
Dividend Vs Growth Option
|Dividend option||Growth option|
|What is it||Investor gets regular income during the duration of the investment by means of the dividends||No regular income. Investor gets benefits only by way of liquidating units at a higher price|
|Suitable for||Investors requiring regular cash flows||Investors not looking for regular cash flows|
|NAV||Since dividends are paid out of fund corpus, fund size decreases after declaration of dividend and this keeps the NAV of dividend option less as compared to growth option||NAV higher than dividend option|
|Taxability||Dividends are not taxed in the hands of investor as Dividend distribution tax (DDT) of 12.5% is deducted by Fund
Selling of units treated as in growth option
|Selling the units within 1 year of buying attracts short term capital gains tax of 15% whereas on selling anytime after that, returns are tax free|
|Benefits||Realization of gains in the funds in cash every year||Long term appreciation of invested funds|
|Risks||Re-investment of earned dividend||Performance of the fund in long term|
Dividend Re-Investment Option
Many AMCs might offer you Dividend re-investment option, under which dividend declared is actually re-invested in the same fund at the then prevailing NAV. This option is not very different from growth option except the fact that re-invested dividend is also eligible for benefit under 80C. However, dividend declared attracts dividend distribution tax (DDT) and compulsorily gets invested in the same fund. This beats the purpose of declaring dividends and leads to un-necessary payout of DDT reducing the fund size. Not many AMCs have this option and hence the same has not been declared in details here.
Let’s Talk Numbers
Back to dividend and growth option, apart from the above mentioned qualitative difference, I tried to analyze the quantitative performance of two options. I extracted data for ELSS of 4 popular AMCs and compared the returns from growth and dividend options. Dividend received from the two options in various financial years were assumed to be invested at the then prevailing fixed deposit rates.
Following is the result-
I find that dividend option is slightly better even at the then prevailing conservative interest rates. In case you can invest the dividend income at a better rate, you overall return from the investment increases.
How do they compare?
Benefit of opting for dividend option is the flexibility that you get out of getting the cash and being able to decide what to do with the available liquidity. In case you think the fund is better, you can any which way invest the dividend in the fund back. Cost that you pay for it is the DDT that AMC deducts before paying the dividend to you. From my analysis, even after paying the DDT and investing at the FD rates, dividend option gives slightly better returns
Thus what it all boils down to is the re-investment risk. In case you can manage this re-investment rate properly, it is recommended to opt for dividend option. But in case you are a conservative investor who does not enjoy liquidity a lot and want to get worry-free investment, growth option is better. With online investing (read here) made easier, you should decide for yourself how to invest rather than depending on financial advisors for such small but important decisions.
Whatever it is, take informed decision and not arbitrary ones.
Happy and profitable investing.
Authors – Priyesh Kesharwani and Praveen Bajaj