When you invest in mutual funds you normally have the choice of 3 plans under each fund viz. Growth Plans, Dividend Payout Plans and Dividend Reinvestment Plans. What exactly is the different between the three of them? Let us understand growth and reinvestment option in mutual funds as well as a comparison of dividend reinvestment plan vs growth plan. What is the difference between growth and dividend reinvestment and dividend plans? But first the concepts..
Growth Plan: In a growth plan of a mutual fund, there is no payout. All profits made on the portfolio are ploughed back into the scheme and therefore the value of a growth plan compounds over the longer term.
Dividend Payout Plan: In this plan, the fund declares dividends out of profits. The NAV of the dividend plan reduces to the extent of the dividends paid and that reduces the NAV of the plan. The NAV of a dividend payout plan will be lower than that of a growth plan.
Dividend Reinvestment Plan: This is similar to the dividend plan with a small difference. In a dividend plan, the dividends are paid out in cash to the unit holders. However, in the dividend reinvestment plan the mutual fund buys units to the extent of the dividend declared by the fund at the post-dividend NAV and credits units to the account.
Understanding the 3 plans with a live illustration..
Let us take the case of 3 plans of Alpha Equity Fund over a period of 1 year since inception..
Payout PlanDividend Reinvestment PlanUnits Bought5000 units5000 units5000 unitsDate of Purchase01-Jan-201701-Jan-201701-Jan-2017Purchase NAVRs.10Rs.10Rs.10Value of PurchaseRs.50,000Rs.50,000Rs.50,000 NAV on 31st Dec 2017Rs.14Rs.14Rs.14Value of InvestmentRs.70,000Rs.70,000Rs.70,000Dividend DeclaredN.A.Rs.2Rs.2Dividend Paid OutN.A.Rs.2N.A.Units issued in lieu of DividendsN.A.N.A.833.3333
#Post Dividend NAVRs.14Rs.12Rs.12Post Dividend Units5000 units5000 units5833.3333 unitsPost Dividend ValueRs.70,000Rs.60,000Rs.70,000# - Dividend of Rs.10,000(5000x2) will entitle him to 833.3333 units. Rs.10,000 / NAV of Rs.12
Three key things emerge from the above illustration on the three different plans..
The number of units remains the same in case of the growth plan and the dividend payout plan but in case of the dividend reinvestment plan the number of units increases as the dividends are reinvested in units.
The NAV remains the same in case of growth fund. In case of dividend payout plan and the dividend reinvestment plan the NAV reduces to the extent of the dividends although the mode of payout is different in both the cases.
The total value of the dividend plan falls to the extent of the dividend that has been swiped out. But the total value of the growth plan and the reinvestment plan remains the same since both are reinvesting the money in different ways.
Which plan should you prefer out of the three plans?
While the choice of the plan will largely depend on your requirements, the following pointers can be useful..
In case this mutual fund is part of your long term financial plan, it makes sense to stick to growth plans. After all, in a growth plan you do not have to worry about reinvesting your intermittent flows at the market yield.
In case you are looking at your mutual fund investment as a source of regular income then you can prefer a dividend payout plan. Of course, in equity funds there is no assurance of regular dividend payouts although this is almost assured in the case of debt funds and liquid funds if you opt for the dividend plans.
Finally, there is the tax aspect to these funds. Let us look at the aspect of equity funds. If you invest in growth funds then the short term capital gains will be taxed at 15% (held for less than 1 year). Long term capital gains (held for more than 1 year) will be tax-free in the hands of the investor. However, post the Budget 2018, there will be a tax of 10% without indexation to the extent your LTCG exceeds Rs.1 lakh in a fiscal year. In case of dividend funds, the dividends will be tax free in the hands of the investor. But with the DDT of 10% imposed in the latest budget on equity funds, the advantage of dividend plans may not be really worthwhile.
What about debt funds? In case of growth plans, STCG (less than 3 years) will be taxed at the peak tax rate but LTCG will be taxed at the rate of 20% after indexation. In case of dividend plans, the dividend is tax free in the hands of the investors but DDT on debt funds is at 28.84%. The relative advantage of dividend plans even in case of debt funds is quite marginal.
The bottom-line is that dividend payout plans can be considered only if you are looking at regular income. The dividend reinvestment plan really does not offer any substantial advantage over equity funds!