Mutual Fund Products based on the Nature of Income Distribution
Mutual funds offer a variety of options to investors, in the manner in which the returns from their investments are structured. At a broad level, the investors have three options: Dividend Option and Growth Option & Reinvestment option.
1. Dividend Option
Investors, who choose a dividend option on their investments, will receive dividends from the mutual fund, as and when such dividends are declared. Dividends are paid in the form of warrants or are directly credited to the investors, bank accounts. There are further choices in the distribution of dividend. In a normal dividend plan, periodicity of dividends is left to the fund managers, who may pay annual or an interim dividend. Though investors know that they would earn a dividend income from their investment, the timing of the pay-out is decided by fund managers. The variants to the normal dividend plan are pre-specified distribution schedules. Mutual funds provide the option of receiving dividends at pre-determined frequencies, which can vary from daily, weekly, monthly, quarterly, half-yearly and annual. Investors can choose the frequency of dividend distribution that suits their requirements. Not all mutual funds provide all of these frequencies as choices, though. Investors can choose from income distribution frequency from the choices available in a particular mutual fund product. Investors choosing this option have a fixed number of units invested in the fund and earn incomes on this investment. The NAV of these investors’ holdings will vary with changes in the value of the portfolio and the impact of the proportion of income earned by the fund to what is actually distributed as dividend.
2. Growth Option
Investors who do not require periodic income distribution can choose the growth option, where the incomes earned are retained in the investment portfolio, and allowed to grow, rather than being distributed to the investors. Investors with longer investment horizons and limited requirements for income choose this option. The return to the investor who chooses a growth option is the rate at which – his initial investment has grown over a period for which he has invested in the fund. The investor choosing this option will vary the NAV with the value of the investment portfolio, while the number of units held will remain constant.
3. Reinvestment Option
Mutual funds also provide another option to investors in the form of reinvestment. Investors reinvest the dividends that are declared by the mutual fund, back into the fund itself at NAV that is prevalent at the time of reinvestment. In this option, the number of units held by the investor will change with every reinvestment. The value of units will be similar to that under the dividend option. The choice of options depends not only on the investors requirements for income and growth, but also on his tax status. The different tax treatment of dividends and capital gains will also impact the choice made by the investor.
Credit: Investment Management-KU