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Mutual funds: Choose the right plan

Oct 22, 2001

As a mutual fund investor you are often confronted by a range of plans for the same fund. This could be a little confusing for the uninformed investor. To the unravel this a little we have explored over here the different plans available to the investors to help take an educated decision.

  • Growth Plan: A growth plan is like a cumulative option wherein the mutual fund does not declare any dividend and the net asset value (NAV) reflects the value of the funds portfolio on a per unit basis.

  • Dividend (payout) Plan: In a dividend (payout) plan, the income fund declares dividends depending on the schemes objective (quarterly, halfyearly, annual) and in an equity fund as and when it has surplus. The dividends are tax-free in the hands of investors. An important point that should be noted by investors is that the dividend plan NAV is generally lower vis--vis the growth plan because while the growth plan has the surplus in it, under the dividend plan the surplus is distributed regularly.

  • Dividend Reinvestment Plan: In a dividend reinvestment plan, the dividend declared is not paid out, rather it is reinvested back at the ex-dividend NAV allocating the investor with additional units in proportion to the dividend amount.

To illustrate how these plans work, we have taken three investors A, B and C who have invested Rs. 5,000/- in a debt fund - Chola Triple Ace under the growth, dividend and dividend reinvest plans respectively. In the example, we have assumed that the three investors enter and exit out of the fund on the same date. Lets see the effect on the returns of A, B and C.

Chola Triple Ace Gr NAV
(Rs)
Units Div
(Rs)
Redemp.
(Rs)
Taxable Tax
(Rs)
Actual
gain (Rs)
2nd July 17.10 292.3977 - 5140.35 140.35 42.95 97.40
3rd Oct 17.58 - - - - - -
Total 292.3977 - 5140.35 140.4 43 97.4

A invests Rs 5,000/- on 2nd July 2001 in Chola Triple Ace (Growth Plan) and is allocated 292.3977 units at the NAV of Rs 17.1 per unit. He redeems the units on 3rd October 2001 at the NAV of Rs 17.58 and his redemption amount is Rs 5140.35, here he makes a capital gain of Rs 140.35. However his actual gain is only Rs 97.4 as he pays capital gains tax (30.6%).

Chola Triple Ace Div NAV
(Rs)
Units Div
(Rs)
Redemp.
(Rs)
Taxable
(Rs)
Tax
(Rs)
Actual
gain (Rs)
2nd July 10.81 462.5347 - 5013.88 13.88 4.25 9.63
*27th Sept 10.78 115.63 - - - 115.63
3rd Oct 10.84 - - - - -
Total 462.5347 115.6 5013.88 13.88 43 125.26
* The NAV is the ex-dividend NAV

B invests Rs 5,000/- on the same date in Chola Triple Ace (Dividend Plan) however he selects a dividend option and is allocated 462.5347 units at the NAV of Rs 10.81 per unit. The fund declares a dividend on 27th September 2001 of 0.25 paise per unit and B gets a dividend cheque of Rs 115.63. He redeems the units on 3rd October 2001 at the NAV of Rs 10.84 and his redemption amount is Rs 5,013.88. In this case his capital gain is Rs 13.88 on which he pays capital gains tax (30.6%). The actual gain of B in this case is Rs 125.26 as the dividend received by him is tax-free.

Chola Triple Ace
Div Re.
NAV
(Rs)
Units Div
(Rs)
Redemp.
(Rs)
Taxable
(Rs)
Tax
(Rs)
Actual
gain (Rs)
2nd July 10.81 462.5347 - 5130.15 14.52 4.44 10.08
*27th Sept 10.78 10.7267 115.63 - - - 115.63
3rd Oct 10.84 - - - - - -
Total 473.2614 115.6 5130.15 14.52 40 125.71
* The NAV is the ex-dividend NAV

With C, the dividend amount of Rs 115.63 is reinvested back in the fund at the ex-dividend NAV i.e Rs 10.78 per unit and is allocated additional 10.7267 units. He redeems all (473.2614) the units on 3rd October 2001 at the NAV of Rs 10.84 and his redemption amount is Rs 5,013.88. In this case his capital gain is Rs 13.88 on which he pays capital gains tax (30.6%). The actual gain of C in this case is Rs 125.71 as here too the dividend received by him is tax-free.

In the above example the dividend reinvestment plan is marginally beneficial over the dividend plan and the growth plan is least attractive. However, this could change significiantly for a longer investment horizon (of over 12 months). Moreover, with an equity or balanced fund (with over 50% equity exposure) the dividend and dividend reinvest option would have been more attractive as the AMC doesnt have to pay the 10.2% dividend tax that an income fund pays.

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