Moneysights column 3 – Mutual Funds – Growth vs Div. Payout vs Div. Reinvestment

In the new moneysights column post, I yet again try to delve into mutual fund choices and the benefits of each. I reiterate – if you don’t have sufficient time to analyze and track stocks, invest your money in mutual funds. The barriers to investing are practically non-existent today (buy/sell a stock at a click of a button, and using your online banking account) and hence all the more care needs to be taken about hard earned money not thrown after bad investment choices.

At the end of the post, I also try to list out which mutual fund type would be suitable, depending on your time horizon and personal needs.

Full post here.

So, after reading this post, you become thoroughly convinced of investing in mutual funds for the long term. It also gave you an idea about some mutual funds which have had a safe track record in addition to generating superior returns. Let’s say you land up at one of the mutual fund offices/websites to buy a mutual fund.

After the customary, what is your first name, last name etc., the mutual fund agent asks you “Sir, which option would you like to go with – growth, divided payout or dividend re-investment?” and “Sir, would you like to go for a debt fund or a equity fund” and you go, “eh? Come again, what are those alien sounding options, and how do they differ from each other?”

This post will attempt to explain these options in brief (there is another option in mutual funds called ‘bonus’. This post will not talk about it except to say that none of the bonus funds are in the top ranking mutual funds and hence it is relatively safe to put them in the ‘hard to understand’ bucket and ignore this option). So, lets begin.

HOW DOES DIVIDEND PAYOUT OPTION WORK?

The mutual fund would declare dividends from time to time and pay out to the investors. For example, if HDFC Top 200 – Dividend payout option is selected, the face value of this fund is Rs. 10, while the NAV is Rs. 50. If the fund declares a dividend, say 10%, the dividend payout is Re.1 (10% of Rs. 10 face value – dividend is never a percentage of NAV, its always a percentage of face value and the face value of almost all mutual funds today is Rs. 10/-). The NAV falls by Re. 1 and becomes Rs. 49, while Re. 1 is paid out to you.

HOW DOES DIVIDEND RE-INVESTMENT OPTION WORK?

Taking the same example above, Re. 1 is not paid out to you. Rather, the same Re. 1 is used to purchase additional units of the same scheme. The NAV still falls by Re. 1 but the number of units you hold increases.

HOW DOES GROWTH OPTION WORK?

No dividends are paid in this option. Rather the gains by the mutual fund scheme are invested back into the same scheme and gain is reflected in the increased NAV.

At this point, you become frustrated with all the mumbo-jumbo and ask the mutual fund agent 1 simple question – “Which option is better for me?”

The answer, as with every financial matter is “It depends!” and it depends on 3 factors –

  1. Type of fund – Equity or Debt
  2. Holding period – Short term or Long term
  3. Type of income – Dividends or Capital gains

Let’s dig in a little deeper and find out which scheme suits you better.

 

Hope you enjoyed the post and more importantly, I hope I have not confused you with my jumbled up thoughts and information.

Feedback, as always, is welcome.

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