Say ‘No’ to Dividend Payout

There are three options available to us whenever we invest in a mutual fund - Growth, Dividend Payout and Dividend Reinvestment. Many investors are not very sure as to which option is better.
However, the choice of option can make a difference in the final returns because of a couple of other factors.

• When the dividend earned is not reinvested, the returns from a Dividend Payout option will be somewhat lower than Dividend Reinvestment or Growth option. In other words, it is our investment strategy, which will affect the returns, not the choice of option per se.
• The applicable tax rate on the type of fund (debt or equity), the holding period (less than or more than 1 year) and the type of earning (i.e. dividend or capital gains) is different. Hence the post-tax return under different options will differ. The major impact, though, is on debt funds. Again an external factor viz. tax which affects the final returns.

While, we considered the tax aspect in the aforesaid article, in this article let us take the first point forward and see how much impact it can make.

Before we do that, here are a few investing traits commonly found amongst the investors:

• Psychologically it is quite comforting to receive cash from our investments from time to time. Therefore, even if we may not need this money, many times we still opt for dividend payout option
• We diversify our investments across many funds, which of course, is a good thing to do. But it also means that the dividends that we receive are a few hundred or thousand rupees. Since the individual dividend amounts are small, we generally tend to spend it rather than reinvest it.

By doing so, we lose out on the full benefits of compounding. All profits earned are, of course, not distributed as dividend. Since they remain in the fund, we earn compounding benefit on that amount. But we lose the benefit of compounding on the amount distributed as dividend. (Even if we were to later reinvest this dividend, there is some time lost in between and also we may have to pay entry loads.)

Now let us take an example and see what we stand to lose if we choose Dividend Payout option vis-à-vis Dividend Reinvestment (or Growth) option. Of course, kindly remember that here we are basically discussing equity funds and long-term investment horizon.