Mutual funds can be classified under many categories based on many parameters like their asset allocation, investment objectives, etc. However, broadly categorised into growth funds or dividend funds.
Given below are a few details of the two types of mutual funds to help investors make better investment decisions.
What is the meaning of growth mutual funds?
Growth funds are an excellent option for wealth creation. These funds reinvest the returns generated back into the fund. These reinvested returns will further generate more returns for the investor increasing their portfolio. These funds, therefore, are able to generate more returns as compared to dividend mutual funds.
What is the meaning of dividend mutual funds?
The purpose of dividend mutual funds, on the other hand, is to provide dividend income for the investors. The dividend income received is distributed to the investors at regular intervals usually on yearly basis. Some funds also provide dividends more frequently like a daily payout option, monthly payout options, etc. The fund however does not guarantee the amount or the frequency of dividend and it is declared only when the company declares it for all its shareholders.
What are the basic differences between the growth and dividend mutual funds?
The fundamental difference between dividend funds and growth funds is the purpose of investment. Growth funds aim at maximizing investor’s wealth while dividend funds target providing a regular source of income to the investors. The other points of distinction between the two are highlighted below.
|Category||Growth funds||Dividend Funds|
|NAV||The NAV of the Growth funds is higher than dividend funds as the returns are reinvested in the scheme||The NAV of the dividend option is lower as compared to growth funds as the dividends are paid out to the investors on a regular basis|
|Returns||Growth funds provide higher returns when the investor stays invested for the long-term investment horizon. This provides the benefit of an extended compounding factor.||Returns in dividend funds are comparitively lower, especially in the dividend payout option. Dividend reinvestment option returns can be higher as the dividends are not paid out but re-invested in the fund.|
|Target investors||Growth funds are suitable to investors with a long-term investment horizon and long-term investment goals.||Dividend funds are best suited for investors looking for a regular source of income and with short-term investment goals.|
|Profit booking||The profits under growth funds are regularly invested in the fund||Profits are distributed to the investors to help them meet their investment goals.|
How are the two funds taxed?
Taxation plays an important role in selecting a fund for investment. It is more often than not the sole reason for investment in mutual funds too. Taxation on mutual funds is on two occasions namely, ln receiving the income from the fund or upon receiving gains through the redemption of units.
Taxation of dividend funds and growth funds is based on the returns received by the investor. In the case of capital gains, these funds are taxed based on the type of fund whether they are debt funds or equity funds.
This is further highlighted in the table below.
|Taxation on dividends||Taxed in the hands of the investor. TDS to be deducted at the rate of 10% in case of dividend paid more than Rs. 5,000|
|Short term capital gains||Equity funds – 15%Debt funds – as per applicable slab rates|
|Long term capital gains||Equity funds – 15%Debt funds – as per applicable slab rates|
As per the recent amendment, SEBI has directed all the existing and new dividend funds to be renamed. This is to ensure that the investors are aware of dividends being distributed from their own capital in the case of mutual funds like in case of equity shares where the dividends are distributed out of company profits.
Therefore, all three dividend funds have to be renamed in the following manner.
|Dividend Payout Option||Payout of Income Distribution cum capital withdrawal option|
|Dividend Re-investment||Reinvestment of Income Distribution cum capital withdrawal option|
|Dividend Transfer Plan||Transfer of Income Distribution cum capital withdrawal plan|
Is it worth it to go in for dividend schemes?
Prior to April 2020, dividends were tax-free in the hands of investors as companies were required to pay Dividend Distribution Tax (DDT) at the rate of 10% in addition to surcharge and cess. This exempt income meant that investors get the dividend income without the tax incidence.
However, with the amendment in the Budget of 2020, dividend income is proposed to be taxed in the hands of the investors at their applicable slab rates. This will increase the tax liability of the investors and will not eventually provide cost-effective returns especially in the case of investors in the highest tax bracket. Hence, it has effectively reduced the benefit under dividend funds and they no longer meet the investment goals of the investors.
Dividend plans have traditionally attracted investors as an alternate source of income to meet their financial needs. However, with the amendment in the Budget of 2020, this benefit has effectively been reduced for all classes of investors (especially those in the higher tax bracket. This has warranted the need to revisit the need for investment in these funds and the fundamental cost-benefit analysis to ensure the investment generates decent returns.
1. What was the rate of taxation on dividends prior to the budget of 2020?
A. Prior to amendment in the budget of 2020, dividends were taxed at the rate of 10% under DDT in the hands of the companies.
2. What is the basic exemption from TDS at 10% under the revised tax laws?
A. A dividend income distributed by any fund or company less than Rs. 5,000 is not subject to TDS at the rate of 10% under the revised tax laws.
3. What is the biggest advantage of growth funds?
A. The biggest advantage of growth funds is the benefit of compounding. It is the easiest and the fastest way to grow an investor’s wealth. This benefit is not always available in the dividend funds if the investor withdraws the dividends received from the fund.
4. What is the investment horizon in growth funds?
A. Long-term investment horizon is best suited in growth funds to ensure maximum investor wealth.