Debt Fund- Dividend vs Growth

In my last article, we saw how debt fund can be used as an alternative to bank fixed deposit. Now lets take a look at what options are available while investing in debt funds. For investment in debt funds, one can choose between dividend payout and growth option.

In dividend payout option, any profit made by the fund is given back to the investor in the form of dividend e.g. If the face value of the fund is 10, NAV is 50 and it declares the dividend of 40%, then the investor will get a dividend of Rs 4. However NAV of the fund will drop down accordingly. Generally dividends are declared periodically but these are not guaranteed.

In growth option, fund house does not declare any dividend instead they reinvest any profit made.

With dividend payout option, liquidity (getting cash) is possible in two forms, selling units and periodic dividend. In this option you do not have to pay additional income tax on the dividend as DDT (Dividend Distribution Tax) is already deducted by the fund house at the time of declaring dividend.

However in growth option, one can get cash only after selling units of the fund. In this option, one need to pay income tax on the profit earned although for long term investment in growth option, one can get the benefit of indexation.

So if you need money periodically, you can choose the dividend payout option else go for growth option as it is a better way of wealth creation.

Debt Fund: An alternative to bank Fixed Deposit

Many people have an inclination towards bank Fixed Deposit as an investment option. Very few people know that investment in Debt Fund can be more tax efficient than bank Fixed Deposit. Interest earned on bank FD is added to your yearly income and taxed as per applicable tax slabs. However if you stay invested in debt fund for more than one year, it is considered as long term capital gain. In current scenario, it is taxed at 10.3% without indexation. You can even take the benefit of indexation to lower your tax.

Let’s look at the following comparison

 

If a person has invested Rs 1,00,000 for 5 years in Bank FD vs Debt fund

Fixed Deposit vs Debt Fund
Fixed Deposit Debt Fund
Investment 1,00,000 1,00,000
Tenure (years) 5 5
Interest Rate (%) 9 9
Interest Earned in 5 years 56,568.000 56,568.000
Income Tax Rate (%) – (depends on your tax slabs) 30.9 10.3
Total Taxes Paid 17,479.512 5,826.504
Post Tax Returns 39,088.488 50,741.496
Interest Earned Post Tax Return (%) 6.6 8.2

 

In addition to better return, you can get advantage of postponing your tax liabilities i.e. in fixed deposit, you need to pay tax every year on interest earned however in debt fund you will have to pay tax only at the time of withdrawal.

For short term FD, interest rates are very low, sometimes not even beating the inflation however, if someone invests in short term or ultra short term debt fund, he can expect better returns without compromising the liquidity.