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The best mutual fund scheme for you

Value Research | May 10, 2005

The choices are endless.

You decided what type of fund to invest in and that was a mammoth task in itself.

But it did not stop there. An array of questions were then thrown to you.

"Would you prefer a dividend scheme or a growth scheme?

"Would you prefer a dividend payout or dividend reinvestment?"

Don't let all this jargon (and innumerable questions) get to you. Here's what you need to know.

Growth and dividend

A mutual fund generally offers two schemes: dividend and growth.

The dividend option does not re-invest the profits made by the fund through its investments. Instead, it is given to the investor from time to time.

In the growth scheme, all profits made by the fund are ploughed back into the scheme. This causes the Net Asset Value to rise over time. The NAV is the price of a unit of a mutual fund.

That is why the NAV of the growth option will always be higher than that of the dividend option because money is going back into the scheme and not given to investors. 

Which should you take?

If you are looking at a long-term investment and are not interested in money being given to you at various intervals, the growth option is meant for you.

If you are keen on receiving an income at various intervals, opt for the dividend option.

But do note, the dividend is not guaranteed.

If a fund declared dividends twice last year, it does not mean it will do so again this year. You could get a dividend just once or you might not even get it this year.

Let's talk about dividends

In the dividend payout option, you are paid the dividend, and the NAV falls.

In the dividend re-investment option, the dividend is not paid to you. Instead, additional units are purchased at the revised NAV.

The bonus option is similar to dividend re-investment, except that the fund announces the bonus ratio instead of dividend.

Hang on! Don't give up.

Let's say you own 100 units of a fund whose current NAV is 20.

So your investment value is Rs 2,000 (100 x 20).

Now, the scheme declares a dividend of 10%. Do note, dividend is always a percentage of face value. Face value is the price of unit of a fund and is Rs 10. So 10% of face value would be Re 1 per unit.

For the bonus plan, the scheme declares a bonus of 1:10. This means an additional unit for every 10 units held.

This is what will happen under the various schemes. 

Before declaration of dividend / bonus



Dividend payout

Dividend reinvestment












Value (Rs)


Rs 2,000

Rs 2,000

Rs 2,000

After declaration of dividend / bonus











Value (Rs)





Dividend received in cash


Rs 100



Additional units





Growth option: No change. Over time, the NAV will grow in value. Whenever you redeem (sell) the units, you get your entire earnings by way of capital appreciation.

Dividend payout: The unit holder will get Rs 100 as dividend while the NAV falls to Rs 19.

Dividend re-investment: The dividend of Rs 100 is not paid in cash but is used to purchase 5.2631 more units.

Bonus option: You get 10 more units, because of which the NAV falls to Rs 18.1818.

The tax impact

Equity funds

These are funds that invest in shares of companies (diversified equity funds and sector funds). They also include balanced funds which have more than 50% of their total investments in equity.

Dividend income from an equity-oriented fund is tax-free.

When you sell any asset you own (house, land, shares, mutual fund units, gold, debentures, bonds), and you make a profit on the sale, it is known as capital gain.

If you sell the units within a year of buying, it will attract a short-term capital gains tax of 10%.

If you sell the units after a year, no long-term capital gains tax.

Debt funds

While dividend income is tax-free in the hands of the investors, it attracts a dividend distribution tax of 12.5% (plus surcharge and cess), which is borne by investors.

If you sell the units after a year, you will have to pay a long-term capital gains tax of either 10% without indexation, or 20% with indexation, whichever is lower. Indexation is used to calculate tax when inflation is taken into account. This is good because it reduces the amount of capital gain and the amount you end up paying as tax.

If you sell the units within a year, the short-term capital gain will be clubbed with the income of the individual investor, to be taxed as per the slab system.

The final call

The rational choice is to choose an option where the tax liability is the lowest.

Of course, the choice may be superceded by some specific requirements. You will consider dividend payout if you need a regular income. Or, if you want your investment to grow over the years, you should opt for the growth option.

  • If you want to invest in an equity fund for less than a year, it is better to go for dividend payout or re-investment option as it reduces your tax liability.

Debt funds are not so simple, as you have to balance out between the capital gains tax and the dividend distribution tax.

  • For a person whose total income falls below the minimum taxable limits, it is advisable to go for a growth or a bonus option. This will save the investor from dividend distribution tax and nor will he be subject to capital gains tax.
  • If you are a tax payer and plan to hold a debt fund for less than one year and fall under the 10% tax slab, then go for the growth option or the bonus option as this will save you from the 12.5% dividend distribution tax, while your capital gains tax will be at the lower rate of 10%.
  • However, if you fall in a higher tax slab of 20% or 30%, then it would make more sense to go for the dividend payout or re-investment option, which will save you more on the capital gains tax, even after factoring in the dividend distribution tax in most of the cases.
  • As regards the long-term investment in a debt-oriented fund, it would be advisable to go for growth or bonus option. This is because the capital gains tax liability on such an investment cannot be more than 10% and you will not shell out the 12.5% dividend distribution tax.

Value Research

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