Feb 16, 2010

ELSS: Dividend Vs. Reinvestment Vs. Growth Option


I’ve already stressed that you should prefer growth option over the dividend option while investing in equity funds including ELSS. It is a false perception that dividend declaration is a sign of good performance by the fund (there is nothing to stop a poor performing fund or fund making losses from declaring dividend). Moreover, the dividend paid is your own money.

In case of ELSS, the only difference is due to section 80C tax benefit. Although, your effective tax deduction is more for dividend option (because your net invested is lower as compared to growth option), but this, in my view, is not a major factor unless you’re short of cash. In the long run, growth option always turns out to be better (unless there is a prolonged recession and markets continue to slide, in that case money already taken out via dividends gets protection from further downfall)

Now, Mr.Ajay asked [see: How to invest in ELSS],

“Could you please clarify the difference between Growth and Dividend Re-Investment? Is it based on the current Tax Policy?”

No doubt, because of this
third option (i.e., dividend reinvestment) it sometimes becomes really confusing to decide: which is the best option among the three? Are you also facing similar dilemma? Don’t worry; this post is going to make it easier for you to decide.

Note: This discussion is only for ELSS funds and not applicable in case of other equity funds or debt funds.

In the case of dividend reinvestment option, the dividend is automatically reinvested and gets eligible for further tax deduction under section 80C (as dividend reinvested is treated as fresh investment). It is similar to recycling strategy of PPF wherein you get double tax benefit on the same money.

For example, A invests Rs 100 in growth option and B invests Rs 100 in dividend reinvestment option. Further, let’s assume that immediately afterwards a dividend of Rs 15 is declared. Now instead of paying out this dividend to B, mutual fund will reinvest the dividend in the same scheme on behalf of B. Afterwards, the portfolio value of both A and B is again similar (Rs 100). So, how does it make a difference? While A will be eligible for tax deduction on Rs 100, B will get tax benefit on Rs 115 by investing Rs 100. B’s decision seems to be wiser. Isn’t it?



Ok, this was the scenario when the dividend is declared immediately after your investment. Now, what if the fund declares a dividend after say 2 years? It is quite possible that in that particular year you would have already exhausted your section 80C limit. And, what if the fund is also lagging in performance? On top of it, as dividend reinvested is considered as fresh investment, the amount of dividend re-invested will get blocked for another 3 years (increase in effective lock-in-period).

In a nutshell, out of the three, growth option always scores over dividend & dividend reinvestment option because your gains remain invested which is good for long term wealth creation. But still if you want to go for dividend option, better go for dividend payout rather than dividend reinvestment because it is more flexible. The option is always open to you whether to reinvest the dividend (for availing further tax concession) or not and in case of reinvestment whether to invest in the same ELSS or some other ELSS fund.


Also see:

1. Best ELSS for 2010
2. Review of Birla Sun Life Tax Relief'96
3. Why ElSS is considered as best section 80C option?

3 comments:

  1. hi fisher

    i feel that chit business(must be highly trusted one) gives more return s than mfs for shorter term like 1-3 years.chits always gave me atleast 18% cosistently(1.50interest) .i have been in chit group and consistently earned 18%and sometimes24%(re2.00 interst) since last 5years.of course chit doesnot has compounding effect.what do u think so.for long term i feel ppf is better ,what do u think so.

    ReplyDelete
  2. Excellent explanation of comparison between growth and div reinvestment options

    ReplyDelete
  3. When we say dividend reinvestment doesn't it mean that the amount that is earned over the principal amount?
    If yes then in above example why did you say balance as 85 after 15 dividend?
    15 is something in addition to 100 as shown in total and growth option is also not clear. Can you please elaborate on the same

    ReplyDelete

You’re welcome to post a comment if you’d like to air your views, or if you’ve any further question to ask, but please stick to the topic and don’t forget to write your name.