Knowing MF Investment Objectives
Your financial goal after having invested in a mutual fund may vary. You may be looking to grow your wealth, or you may be conservative and happy with just receiving a regular income. You may be looking for capital appreciation from your investment. Somebody else may look for more significant returns over the long term. Based on your mutual fund goals, equity and debt schemes are categorised into dividend, growth and reinvestment options.
Dividend for regular income
Mutual funds provide growth and dividend options. You make your choice based on what your mutual fund goals are.
When you invest in the dividend option of a debt or equity mutual fund, you receive regular income in the form of dividend payouts from the mutual fund.
Growth option for capital appreciation
If you are looking for long-term gains and capital appreciation, you can opt for growth option in mutual funds. Here, funds do not pay out dividends but reinvest the profits. Because of this compounding effect, the net value of the mutual fund increases when you redeem it.
Mutual funds also come with a dividend re-investment option. With the help of this option, the investor can opt to re-invest the dividend to buy more units of the fund instead of receiving the dividend in cash. In this case, the dividend amount is, however, taken out from the net asset value, which is the gross asset value minus expenses ratio.
A mutual fund with a dividend option shares profits with its investors through regular dividend payouts in the form of cash. Since the dividend is stripped from the net asset value, the NAV of a mutual fund with a dividend option may be lower than that of a mutual fund with a growth option. This is not an indicator of how the two funds have performed.
Advantages of the dividend option
- This could be a good option for senior citizens or generally risk-averse investors whose investment goal is to receive a steady income
- Investment in short term debt mutual funds with dividend options are ideally suited for this class of investors
If the investor chooses not to reinvest dividends, he stands to lose out on the power of compounding through reinvestment. It is a feature available for mutual funds with growth option. This increases the value of the investment over the long term. The power of compounding involves reinvesting the dividend equivalent in buying more units of the mutual fund. So, during redemption, the total value of your invested capital substantially increases.
The dividend received by the investors is tax-free, but, the mutual fund pays the dividend distribution tax of 10% not including surcharge and cess. This tax is deducted from the investors’ returns as dividend as expense ratio. In debt schemes, the DDT on dividend payout is 25% not including surcharge and cess.
Mutual funds with growth option do not give out dividends. The notional profits (called notional since they cannot be cashed out) are also reinvested regularly. Since the entire sum one invested stays invested along with the notional profits, it increases the total value of the investment by the time the mutual fund is redeemed.
- Mutual funds with growth option may not give great returns in the short term, but they help in building wealth and are therefore suited for long term investors. If your mutual fund goal is to build capital, then this is the best option for you.
- Long-term investors looking for wealth creation as their primary mutual fund objective may prefer this option for equity funds as in the long run, equity funds give good returns and avoid short-term risks of the market.
- Also, investors don’t need to worry about reinvesting the dividends or profits for capital appreciation.
You cannot invest in this option if your mutual fund goal is to receive a monthly income.
If you hold your investment in equity growth funds for less than a year, then your profits would be taxed at 15% as short-term capital gains tax. For equity growth schemes held for more than a year, you will be taxed at 10% without indexation (price adjusted for inflation) for gains exceeding Rs. 1 lakh in a financial year.
For debt fund growth schemes, funds held for less than three years will be taxed as per your tax slab. Debt funds held for more than a period of three years will be taxed at 20% after indexation.
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Mutual Fund investments are subject to market risks, read all scheme related documents carefully before investing.