If you are looking for low-risk investment avenues that offer returns higher than bank deposits, debt mutual funds could be the best option for you. With a long-term investment outlook, you can build considerable wealth by opting for a growth option. Alternatively, you can generate regular income from your mutual fund investments with a dividend option.
For many, a regular income opportunity is highly appealing, leading to the selection of dividend option for a debt mutual fund. However, you always have the option to switch from one dividend to growth plan.
The question is, should you switch from dividend option to growth in debt funds? Here are the key factors that you should consider before making this transition.
Your investment objective
Start by revisiting your original investment objective. If you want to grow your wealth at a fast pace and maximise your returns over a period of time, a dividend option could hurt you more than help you. But if you intend to generate regular income from your investments, you need not make the switch to a growth option.
Income generated from dividend option
Next, you need to consider the income generated from dividend payout and how it factors in your overall financial goals. If you don’t depend on this income to meet your immediate needs, perhaps you should switch from dividend option to growth in your debt fund. But if this income is significant and helps you pay your bills, staying with this option is a better plan.
NAV difference between both options
Since dividends are nothing but profits distributed by a fund house, dividend plans often have a lower NAV than growth plans. For growth plans, the profits earned by a scheme are reinvested into the fund, appreciating its value. So, if you are leaning towards making the switch, check the NAV difference between both plans. Also, be prepared to settle with lesser units, once you make the dividend to growth funds switch.
Tax on dividends
Earlier, debt mutual funds attracted a dividend distribution tax (DDT), making dividends tax-free in the hands of investors. But, from FY 2020-21, DDT has been removed and dividends have become taxable at the rate of the relevant tax bracket of the investor. This could result in a significant loss in returns if you are in a higher tax bracket.
Exit load on switching
The dividend to growth funds switch is not really a switch. The fund house treats it as redemption or sale of the debt fund units held in the dividend option, and new purchase of units in the growth option. This whole process attracts an exit load on the units held.
Applicable capital gains tax
The dividend-growth funds switch also attracts capital gains tax. If you were invested in the dividend option for less than a year, the switch will attract a short-term capital gains tax of 15%. If you were invested for more than a year, you will have to pay a long-term capital gains tax of 10%, provided your capital gains exceed Rs. 1 lakh.
In conclusion, by comparing the cost of switching with the potential losses of staying on, you can make an informed decision. Assessing all these factors can effectively help you decide whether you should switch from dividend to growth option in your mutual funds.