Famous English poet William Blake has said, "Exuberance is beauty." and this is what most of the financial markets in the world are trying to display thru "Financial Exuberance". But it is not that beautiful as that famous quote by a poet. Nowadays number of financial products are launched which are very complex in nature and due to this complexity financial engineers too are not clear about the product which they launch in the market and its implications in the long run. To make them simple, marketing team makes all their effort to persuade investor to fall for them and due to lack of knowledge about it many of investor purchase it without even assessing whether it goes well with their own objective or not. One of the best examples is Mutual Funds.
With so many MF options such as Dividend payout, Dividend re-investment, Growth and Bonus, are provided by MF houses to investor for investment, it's difficult for an investor to choose from them. Even many of investors are not aware of all these options and how these work and which is the most suitable option for them.
It is important for an investor that before making any choice of option, he/she should be aware what they actually mean and how they actually function in favour of their needs.
- Dividend payout option – Dividend payout option proposes to timely pay distributable profits to investors in the form of dividends, thereby giving investor facility to liquidate their profits.
- Dividend re-investment option – under this option MFs declare dividend but instead of paying to investor they goes in buying additional units of the same MF scheme and investors continue to book higher profits and keep re-investing them in the MF scheme.
- Growth option – under this option, investors do not receive any kind of dividend instead of dividend they enjoy the compounded growth in their value if MF scheme, subject to the investment bets taken by the fund manager.
- Bonus – under this option, investors receive bonus units in accordance to a ratio declared by the fund house instead of getting regular dividend. This option usually offered by very few fund houses.
Now the big question is which option is best for investors. Well it depends upon what an investors financial calls in future. Investors financial plan are drawn by investor planner ideally should be a function of your age, income, expenses, your future goals and mainly your risk appetite.
For example :- If you are an old person, your income is moderate, your commitment towards expenses are high , risk appetite is low and your about to meet with your financial goals then you must opt for dividend payout option instead going for a growth. Whereas, if you are young, your income is high, your expenses are lower, risk appetite is high and you are far away from your financial goals then you must opt for growth option because you don’t need regular cash flow so you can opt for growth option.
However, if you still want to book profits at regular intervals then you can opt for dividend payout option while investing your money in MFs.
For dividend re-investment option is concern I would like to say that it doesn’t make any sense because indirectly it gives you the same benefit which Growth option provides. I would say that growth option provides more benefits of compounded because its NAV wouldn’t get effect due to the impact of dividend declaration.
As far as I know people don’t consider these aspect and has a common misconception that ‘Dividend payout option is always better’, since it provides a better return in the form of dividend. Which is not true? I am explaining this with one example below table. Let’s assume that someone wants to invest Rs. 10000 in HDFC Equity fund on 1Jan 2000 in the dividend and growth option each, at an NAV of Rs. 20.14 and Rs. 24.91respectively, and going to stay with this investment for next 11 years. He’ll earn return of investment nearly 15% in dividend option and 24% in growth option.
HDFC Equity (Dividend) | HDFC Equity (Growth) | ||||
NAV Date | NAV (Rs.) | Dividend (%) | Cashflow (Rs.) | NAV (Rs.) | Cashflow (Rs.) |
03-Jan-00 | 20.14 | -10,000.00 | 24.91 | -10,000.00 | |
24-Mar-00 | 21.52 | 30 | 1,489.57 | 26.66 | |
22-Dec-00 | 12.66 | 17 | 844.09 | 18.06 | |
15-Mar-02 | 13.47 | 12 | 595.83 | 22.42 | |
15-Jul-03 | 17.1 | 20 | 993.05 | 31.29 | |
30-Sep-03 | 18.79 | 25 | 1,241.31 | 38.87 | |
19-Mar-04 | 20.79 | 15 | 744.79 | 40363 | |
30-Nov-04 | 23.45 | 30 | 1,489.57 | 60.31 | |
17-Mar-06 | 41.88 | 50 | 2,482.62 | 123.52 | |
07-Mar-07 | 40.35 | 50 | 2,482.62 | 135.17 | |
07-Mar-08 | 45.45 | 55 | 2,730.88 | 173.18 | |
19-Mar-09 | 23.253 | 30 | 1,489.57 | 100.801 | |
25-Mar-10 | 46.947 | 40 | 1,986.10 | 233.855 | |
22-Mar-11 | 49.093 | 24,375.87 | 266.851 | 1,07,126.05 | |
Return CAGR | 14% approx | 12% | 24% approx | ||
(Source : HDFC Mutual Funds)
Above Example indicates that opting for a dividend option does not always give good returns, when we compare them with Growth option.
I have seen that people usually compare the NAV of dividend and growth option and then wonders why the NAV of dividend is lower than the growth. It is because when MFs declare dividend then hen NAV drop to the extent of dividend declare and if there is some downside volatility in market then even more. Whereas in case of growth, NAV of growth totaly depend on market movements and the other expenses which fund is exposed to.
So next time while selecting between dividend and growth option pay attention towards your financial goals. If you are looking for compounding benefits then you should opt for growth option. Whereas if you are looking for a regular income or want to book profits at same intervals then you should consider dividend payout option.
