Benefits of investing in mutual funds

Nowadays, mutual funds have become a popular vehicle of investment. This is mainly because the investors are beginning to realise the benefits of investing in them.

Funds offer different options to claim your returns. One is 'dividend' and then there is 'growth'.  Further, under the dividend option there are dividend payout and dividend reinvestment options. Let us analyse these different options.

Growth Option

Under the growth option there is no interim payout. If there is surplus with the fund house, it gets reinvested.  Normally, the net asset value (NAV) of growth scheme is higher than the dividend schemes. Therefore, it is recommend for an investor having long term investment horizon.

Dividend Option

Under this option, fund house declares a dividend every year depending upon the distributable surplus. Of course, this brings down the NAV but by declaring dividend, the fund generally gains more popularity. Dividend is always declared on the face value of Rs 10, so if fund house declares 100 per cent dividend, the investor will receive Rs 10 as dividend. For those investors who want regular income this is the best option.

Now under the dividend option, there are two sub options, dividend payout and dividend reinvestment. In the latter option,  the dividend gets reinvested at the ex-dividend NAV.  Suppose one had invested Rs 1 lakh in fund A on April 1, 2005, at the NAV of  Rs 50, so the investor is holding 2,000 units of the fund A.

After 1 year, the fund had appreciated by 40 per cent. It declares a dividend of 100 per cent (Rs 10) under the dividend option.  In the second year, it appreciates by another 30 per cent. Now let us evaluate the gains under all these options to find out the difference. A little  bit of number crunching would tell you that  is clear that the gains are exactly the same under the growth and dividend reinvestment options.

As far as numbers go, the value of the two investments would be Rs 1,82,000 on April 1, 2007. Gains under payout are lower at, Rs 1,56,000 because there is no benefit of compounding.

Tax impact 

Now as far as tax liability goes, there is some difference between the growth and dividend payout options. That is, when the investor goes for the growth option, one attracts tax from the day when the units were brought. That is, April 1, 2005.

However, in the dividend payout scenario, one attracts an additional tax burden, as on April1, 2006, 333.33 additional units have been added to his portfolio. Thus, this is the major difference between the growth and dividend reinvestment options. So, it is clear that sometimes the investor has to shell out more capital gain tax in respect of the dividend reinvestment.

In short, before taking any call, the investor, should determine his time horizon, his needs, whether he needs regular income or want his money to grow over a long period of time and depending on all these factors, he should choose the option that suits him/her best.