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Monday, May 9, 2011

Understanding Growth, Dividend & Reinvest options of Mutual Fund

Patience pays when you invest in Equity Funds:

If you choose a good quality equity fund, your investments are likely to appreciate steadily over time, overcoming most temporary setbacks. Therefore, the focus should be on investing for the long term. Before you invest your money, make sure the schemes are selected taking into account the track record and the quality of the portfolios. Your Mutual Fund portfolio should provide you an adequate exposure to each of the market segments depending on your risk profile. In other words, investors need to re-look at equity funds, not with the rose coloured spectacles but with the high powered ones of analytical selection.

Growth, Dividend & Reinvestment options:

It is equally important to select an appropriate option. Mutual funds offer dividend, growth and dividend reinvestment options. For someone who is keen to book profits periodically, dividend option can be the best. Besides, one can re-invest the tax free dividend amount in some new ideas at that point of time. However, an investor looking to build a corpus for retirement or any such long term objective, the choice could be between growth and reinvestment option.

First, let us understand the "growth" option. Under this option, no dividend is declared and the net asset value (NAV)moves up and down depending on the market movement. The tax incidence occurs only when you redeem your units and the rate of tax depends on the period for which the money remains invested.

Under dividend reinvestment, the funds declares dividend, which as per current tax laws is tax free, and reinvests the dividend amount into the fund at the post dividend NAV. If the dividend is declared within one year of investment, a part of the short term capital gains is converted into tax free dividend. However, an investor would have to hold units allotted on account of reinvestment of dividend for one year to make the gains on these units tax free. On the other hand, under the growth option, once an investor completes one year, he can redeem any number of units without having to pay any capital gains tax.

As can be seen, the major differences between the growth and dividend re-investment options are related to taxation. Remember, choosing an option is as important as selecting a good fund. Therefore, consider various aspects relating to tax and time horizon before deciding one.

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