We all love customization. Don’t we!? One highly underrated aspect of mutual funds is the customization they provide in terms of dividend payout. Usually when we invest in stocks, whenever a company chooses to provide a dividend payout, it automatically credits on to our account. We cannot choose to automatically reinvest the money. Mutual fund houses offer options based on this Dividend mutual funds and Growth mutual funds
Dividend mutual funds
In a dividend scheme, the fund houses distribute the returns to the holders of the mutual fund. The fund houses invest in stocks of companies that pay a high dividend, which would in turn allow them to declare dividends to the unitholders.
Growth mutual funds
The growth scheme does not distribute periodic dividends to the unitholders. Rather, their ultimate motive is to create capital appreciation to its investors. When a mutual fund house earns dividend from its investments, it reinvests such return to reap the benefit of compounding.
Nothing else changes usually. The fund managers always maintain same portfolio for both options. Based on your investing principle and goal, you can choose a suitable option. Over long run, if you are not in need of dividend, it is always advisable to invest in “Growth” schemes. This will enable you to benefit from the compounding effect.
DDT makes Growth mutual funds a better option
However, there is a big catch here in “Dividend” option. There is a fixed DDT, Dividend Duty Tax, levied during the payout and this varies from 10% for equities to 25% for Debt funds. So in essence, if you choose Dividend option, you should be willing to part away 30% of it in the name of tax.
However, this bring another question of “What if you want a constant source of income?” To circumvent the taxation, investors can opt to choose “Growth mutual funds” instead and then set up a “SWP” (Systemic Withdrawal Plan). You can receive constant revenue at a much lower tax whilst dividend is reinvested.
Similar to dividend-based classification, there is also classification based on which medium investment in mutual funds happen and that has severe implication on long-term wealth generation. Nevertheless, that’s a topic of discussion for another day. You can find it here!