How To Grow Money From Mutual Funds?

Mutual funds are known for helping investors make money. With the support of expert fund managers, investors can meet their financial goals and match their risk-appetite to their investments perfectly. There are two primary ways to make money from mutual funds;

• Earn Dividends
• Gain in Capital

When choosing a mutual fund, you are usually given a choice to choose between a Dividend (D) option or the Growth (G) option. The first one lets you earn dividends and the second one leads to capital appreciation. Let us look at both of these individually.

When you choose the dividend option, the fund manager announces dividends on the schemes based on the profit generated, which are then distributed among the investors in proportion to their holdings.

The Asset Management Company (AMC) invests in debts or equities of organisations that usually announce dividends regularly. These are then passed on to the investor. The dividends can be used by the investor for his/her expenses or investing it somewhere else. Investors can also opt for Dividend-reinvestment option where the dividends earned are re-invested into the same fund, and more units are bought at the current NAV.

The dividends earned are added to the income of the investor and taxed as per the tax slab of the relevant financial year.

Dividend mutual funds can be a great way to compliment your current income or earn extra income from your investments. Dividends are also an indicator that the investments are doing well.

Paying dividends to the investor means the capital does not grow at the same pace as the growth fund. Moreover, with the recent abolishment of DDT in the budget of 2020, the dividend option, especially the equity funds, have become lesser lucrative. Now the investor may have to pay tax up to 30% on the same earnings depending on their tax slab.

Growth fund reinvests the earnings/dividends accrued to the investor back into the fund, thereby increasing the Net Asset Value (NAV) of the units held by the investor. Thus, it leads to compounded capital gain for the investor. This gain can be realised upon redeeming the units of the fund.

When the fund is performing well, the AMC may announce dividends on its fund. When an investor chooses the growth option, the dividends are invested back into the fund and the NAV of the units increases proportionately. This is why you will notice that NAV of Growth (G) funds is more than the Dividend (D) funds.

When you opt for the growth option, it leads to capital appreciation. In such a case, the gains are taxed when the funds are redeemed. The taxation will differ based on the asset class of the fund.There are two categories of funds in terms of taxation on capital gains;

• Equity Funds These are funds that invest 65% or more of its pool of funds into equities and related instruments. If the funds are held for less than 1 year, the gains are considered as Short-term Capital Gains (STCG) and taxed at 15%. For funds held than more than 12 months, the gains are considered as Long-term Capital Gains (LTCG). Gains more than Rs 1,00,000 in a financial year are taxed at 10%.
• Debt Funds Funds that have equity exposure less than 65% are considered as debt funds for taxation purposes. Gains from debt funds held for less than 36 months are considered as STCG and gains on funds held for more than 36 months are considered as LTCG. STCG on debt funds are added to the investors’ annual income and taxed as per the slab of the relevant financial year. LTCG on the funds are taxed at 20% after giving the indexation benefit to the investor (to account for inflation).

Arbitrage funds are also classified as equity funds for taxation purposes as they invest predominantly into equities or related instruments.

The growth option allows the investor to take advantage of the compounded returns on their investment.

When the market enters a bearish phase, it can lead to capital erosion impacting your goals adversely. As they provide no dividends, the only hope for the investor is to earn from the capital gains made over the years.

It is essential to choose the right option based on your financial goals and your risk appetite. However, experts would suggest you have a well-diversified portfolio that contains a mix of both growth and dividend mutual funds to ensure that you earn regular income as well as stand a chance to appreciate your capital as well.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.