Growth options save you from undue problems

FUND QUERIES

"" IU Sancheti

Since you have been receiving dividends for some time, you must have noticed after a dividend payout is implemented, the net asset value (NAV) of the fund goes down. In case of a growth option, your gains remain unrealised.

The main difference between the two lies in reinvestment of gains received and the tax treatment. As far as returns from the two are concerned, there is not much difference.

There is one school of thought which believes that given the uncertainty and risk in equity markets, profit booking in form of dividends is a good strategy rather than waiting for the 'right time' to get a good return.

In your case, since the dividends received are being reinvested, you end up incurring further entry loads. This can be avoided by remaining invested in the fund under the growth option. Also, the time it takes to receive dividends and redeploy them can be better spent by keeping the funds invested. Added to this is the dilemma of finding good opportunities to invest in.

The tax implication that can potentially alter your returns under the two options is applicable more for debt funds and less for equity funds. This is due to the imposition of dividend distribution tax of 12.5 per cent (plus surcharge) for debt funds. Such a distribution tax implicitly eats into the corpus. Equity and balanced funds are exempt from paying such a distribution tax.

Further, in case of debt funds, a short-term capital gains tax, depending on your income bracket, is also levied for units redeemed within a year of investment, and in case of equity funds, a tax of 10 per cent is applicable in the short term. A long-term capital gains tax of 10 per cent (plus surcharge) is applicable only for debt funds and not for equity funds.

Is there any mutual fund categorisation based on tenure of investment? If so, which are the ones suitable for long-term and short-term investments? I want to invest some money for my granddaughter, and wish to redeem it after 15 years for her educational expenses. Please suggest a mutual fund product or category.

"" AV Srinivasa

Yes, there are different classifications within mutual funds, which are appropriate for different investment tenures. Ideally, a long-term investor with a high-risk appetite can opt for equity diversified funds, as in the long run, the equity asset class has always outperformed other asset classes by a good margin. For an investor with a short time horizon, there are varying fund options.

For instance, a person who wants high liquidity and higher returns than bank deposits can look at ultra short-term debt funds that invest in short-term financial instruments. An investor with a medium term horizon of 1-2 years can look at hybrid funds with varying equity and debt exposure.

You could also divide your money between diversified equity funds and balanced funds. You can aim at a 75-80 per cent equity exposure, with the rest invested in debt instruments. As you reach closer to your targeted 15 years, you start shifting your equity investments to debt funds.

Start the process after 11-12 years, and gradually reduce the equity allocation. This can be done by instituting a systematic transfer plan, wherein a fixed amount is transferred from specified equity funds to debt funds at regular intervals.

This is similar to a systematic investment plan (SIP) except that in a SIP the investment flows from a bank account into the fund, and here it flows from one scheme to another. The advantage of such a move is that you end up avoiding the issue of market timing, while liquidating your equity investments, which in turn safeguards your investments from the effects of market volatility.