The world of financial innovation and exuberance has introduced many of us to numerous exotic financial products. Excitement is galore for sure; but the big question is, whether it is making it simple and lucid for the buyers to understand these financial products. Apparently the exuberance of financial innovation is so immense that the financial engineers too aren’t very clear about the product they launch, and their implications in the long-term. But interestingly to make it simple and lucid (which it never is!), the marketing team (along with the product team) are taking every effort to persuade you to fall for this financial exuberance, which indeed many of you investors do fall prey to, and forget to assess whether it is really meant for you.

Let’s take the case of mutual fund investing. With so many options such as dividend payout, dividend re-investment, growth and bonus, provided by mutual fund houses while investing in mutual fund schemes, many of you aren’t even aware how each of these options work, and which is the most suitable option for you.

It is noteworthy that, before you identify your choice of option, it is vital for you to be aware of what it means and how they function.

• Dividend payout option - This option proposes to timely pay distributable surplus / profits to you in the form of dividends (either through cheques or ECS (Electronic Clearing Service) credits), thereby facilitating you to liquidate profits.
   
• Dividend re-investment option - Under this option instead of paying dividend cheques or providing ECS credits, the dividend amount declared by a mutual fund scheme, goes in buying additional units of the same scheme (where you are invested), and you continue to book profits and keeps re-investing them in the same scheme.
   
• Growth option - Under this option, you do not receive any dividends. Instead continue to enjoy compounded growth in value of your mutual fund scheme, subject to the investment bets taken by the fund manager.
   
• Bonus option - Under bonus option you are not paid regular dividends. Instead you continue to receive bonus units in accordance to a ratio declared by the fund house. (very few mutual fund houses have this option)
   

Now as far as question of ‘which is the suitable option?’ is concerned, it depends upon what your financial plan calls for. Your financial plan drawn by your planner should ideally be a function of your age, income, expenses, nearness to goals and risk appetite.

So say if you are young, your income is higher, your commitment towards certain expenses are lower, your willingness to take risk is high and you are many years away from your financial goals; then you may opt in for the growth option (while investing in mutual funds). And remember at a young age, since one generally doesn’t look for a regular cash flow (as generally a regular income flows in the form of earnings), one should ideally opt in for the growth option.

However despite the financial planning aspects stated and the regular income earned, if you are still looking for a cash flow (in the form of dividend) or want to book partial profits at regular intervals, then you may consider the dividend payout option while investing in mutual funds.

While many of you may still appear unconvinced and still perceive that dividend option would offer you better "dividend adjusted returns" as compared to the growth option, let us assess whether that’s really true.

NAV Date	HDFC Top 200 (D)			HDFC Top 200 (G)
	NAV (Rs)	Dividend %	Cash Flow (Rs)	NAV (Rs)	Cash Flow (Rs)
07-Jan-2000	25.81	-	(10,000)	25.04	(10,000)
24-Mar-2000	24.81	25	969	24.90	-
25-Aug-2000	16.03	21	814	16.03	-
23-Feb-2001	13.84	20	775	15.87	-
15-Mar-2002	12.44	20	775	16.46	-
31-Oct-2003	19.90	25	969	33.20	-
08-Mar-2004	21.96	15	581	41.92	-
15-Dec-2004	24.07	30	1,162	49.35	-
17-Feb-2006	36.31	45	1,744	85.04	-
07-Feb-2007	42.97	50	1,937	114.81	-
07-Feb-2008	48.13	50	1,937	145.51	-
05-Mar-2009	23.36	30	1,162	78.87	-
11-Mar-2010	46.58	40	1,550	180.11	-
10-Mar-2011	48.00	40	1,550	203.07
23-Dec-2011	37.55		14,549	173.42	69,258
Returns (CAGR)		15.4%		17.6%

NAV as on December 23, 2011
(Source: ACE MF, PersonalFN Research)

The table above reveals that if one were to invest 10,000 in the HDFC Top 200 Fund on January 7, 2000 in the dividend and the growth option each, at an NAV (Net Asset Value) of 25.81 & 25.04 respectively, and were to stay invested for a period of 11 years; the return on investments would be have been greater under the growth option (17.6% CAGR), than under the dividend option (15.4% CAGR).

This thus indicates that opting for a dividend option does not always give better returns, when compared to growth option.

Also very often we have seen individuals comparing the NAVs of the "dividend option" with the NAV of the "growth option" and the wonder why it is lesser than the other. Here in our view, we think that they fail to recognise that the NAV under the dividend option falls after the dividend record date to the extent of the dividend declared by the fund, plus due to the downside volatility it is exposed to. While in case of the growth option it merely paves its way with the market movement and the other expenses which the fund is exposed to.

However, this seemingly simple concept is often lost on you. And more often than not, it is the significant amount of misinformation and financial exuberance which is to blame. Some fund houses in order to garner more AUMs (Assets Under Management), in the past have attracted investors by declaring enticing dividends and their marketing teams have also cashed-on this (and they still do!) by giving fancy ads.

But now, as SEBI (Securities and Exchange Board of India) has proposed norms which bar mutual fund houses from tapping the unit premium reserve account and instead declare dividends from realised gains (i.e. profits booked in the event of upswing in the markets); the quantum of dividends is expected to reduce. In fact at present some mutual fund houses have even held back their plans of declaring hefty dividends (as seen in the past).

What should you investors do?
Remember, while your agent / distributor / relationship manager may give you the dividend track record of a mutual scheme and try to display financial exuberance, it may not carry much relevance now (in context of the new norms proposed for dividend declaration). Hence while selecting between the dividend option and growth option, see what suits your financial plan / needs primarily. If you are looking at the benefits of compounding then you should ideally opt in for the growth option. Whereas, if you are looking at regular cash flows (in the form of dividends) or want to book profits at regular intervals, then you may consider the dividend (payout) option while investing in mutual funds.

While exuberance may seem beautiful for the manufacturers and distributors of financial products, in our opinion you really need to evaluate whether it really suits your need and whether its adds beauty to your investment portfolio.

This article was written exclusively for Equitymaster, India's leading Independent research initiative. Trusted by over a million members all over the world, Equitymaster is known for its well-researched, unbiased and honest opinions on the Indian Stock Market.

Disclaimer: This note / article is for information purposes and Quantum Information Services Limited (PersonalFN) is not providing any professional / investment advice through it. The recommendation service, views, articles and other contents are provided on an "As Is" basis by PersonalFN. The facts mentioned in the note are believed to be true and from a public source. The Service should not be construed to be an advertisement for solicitation for buying or selling of any scheme / financial product. PersonalFN disclaims warrants of any kind, whether express or implied, as to any matter/content contained in this note, including without limitation the implied warranties of merchantability and fitness for a particular purpose. PersonalFN and its subsidiaries / affiliates / sponsors / trustee or their officers, employees, personnel, directors will not be responsible for any direct/indirect loss or liability incurred by the user as a consequence of his or any other person on his behalf taking any investment decisions based on the contents of this note. Use of this note is at the user's own risk. The user must make his own investment decisions based on his specific investment objective and financial position and using such independent advisors as he believes necessary. PersonalFN does not warrant completeness or accuracy of any information published in this note. All intellectual property rights emerging from this note are and shall remain with PersonalFN. This note is for your personal use and you shall not resell, copy, or redistribute this note, or use it for any commercial purpose. Please read the terms of use.

Add Comments

Comments
bksinghus@yahoo.com Jan 07, 2012 What happens in case a dividend reinvestment option is chosen. It will be interesting to see .
capthe@hotmail.com Jan 19, 2012 Hey, that's a clever way of thinking about it.

 1