Confused about selecting a fund option while investing in equity mutual funds? Don't understand the basic difference between dividend payout, dividend re-investment, growth or bonus options? Here's help. We bring you a comprehensive guide on the four basic mutual fund concepts to help you make an informed decision while investing.

Dividend payout option

In dividend payout option the fund declares dividend to their investors from time to time. As, you can observe in illustration 1 given below:

Illustration 1: An investor invests Rs 50,000 on January 2, 2006 in the HDFC Equity Fund (Dividend) payout option. On a regular basis the fund pays out a certain percentage of dividends to investors. On June 30, 2010 the fund generated returns of 90.01 per cent adding up total dividend payout and total appreciation in invested amount.

Now, it is up to you as an investor to invest the dividend returns for future consumption or utilise it for your regular expenses. But, we recommends you re-invest the dividend payout for future consumption.

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In dividend re-investment option the fund declares divided on a regular basis, but it is re-invested into the same fund. So, from that amount new units are purchased for an investor. As you can observe in illustration 2 given below:

Illustration 2: An investor invests Rs 50,000 on January 2, 2006 in the HDFC Equity Fund (Dividend) re-investment option. On a regular basis the fund declares a certain percentage of dividends to investors and they are re-invested into the fund by buying new units at prevailing NAV. On June 30, 2010 the fund generated total returns of 102.21 per cent.

Comparison between returns of dividend payout and dividend re-investment option

There are higher returns in the dividend re-investment option (as shown in illustrations 1 and 2). This was possible because the investor re-invested the dividend declared amount into the scheme to buy new units. This generated a higher return on the investment, compared to the dividend payout option.

By investing in the same fund for the same period of time the investor has generated 6.41 per cent higher returns by investing in the dividend re-investment option, as compared to dividend payout option.

This was considered only for investing in one mutual fund scheme. An investor basically invests into multiple schemes. Now, if you have opted for dividend payout in all schemes then there will be much higher losses.

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In growth option, you will not receive any payout, but the value of your holdings will be appreciated in the long term. The returns keep on fluctuating based on the net asset value of a fund. As, you can observe on illustration 3 given below:

Illustration 3: An investor invests Rs 50,000 on January 2, 2006 in the HDFC Equity Fund Growth option. The invested amount buys units in this particular scheme. Now, on June 30, 2010 the fund generated total returns of 136.3 per cent. In growth option there is no dividend declared. The return from a fund is completely dependent on the net asset value into number of units at any given point of time.

Comparison between returns of dividend re-investment and growth option

The dividend re-investment option fund declares dividend payout, but they are reinvested into the scheme to buy new units at prevailing NAV. On the other side, in growth option there is no dividend payout option. The amount is invested to buy the units in particular scheme.

In growth option the returns fluctuate with net asset value. In the long term there are higher returns in the growth option which is well illustrated by comparing the returns on illustrations 2 and 3. Growth option generated 16.86 per cent higher returns compared to dividend re-investment option.

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There are few mutual fund schemes which give the option of bonus. In this, the asset management company decides to declare certain units as bonus to their investors. It can be anything such as 1:2, 1:5, 1:10 or any other ratio.

In illustration 4 we have assumed the NAV and bonus declared for Reliance Pharma (Bonus) fund to understand this option.

Illustration 4: An investor invests Rs 50,000 in the Reliance Pharma bonus option. The bonus assumed is 1:10 in this scheme. Now, this fund has declared bonus units in the 1st and 2nd year after initial investment.

This has reduced the NAV after bonus and has increased the holding of units in the hands of the investor.

In the event, the 3rd year investor decides to exit from this fund and manages to generate returns of 69.4 per cent.

Tax implication

The funds such as diversified, sector or balanced which invest into equity of companies with holding of 65 per cent or more are considered as equity mutual fund schemes.

Dividend income from an equity oriented fund is tax-free.

Exit from a mutual fund scheme within a year of investment will impose 15 per cent short term capital gains tax.

Exit from a mutual fund scheme after a year of investment is considered as long-term investment which implies no tax on capital gains.

By now you would have understood the concepts and differences between Dividend Payout, Dividend Re-investment, Growth and Bonus options. So, don't confound yourself with mutual funds terminology. Be clear with your investment goals and opt for the right equity fund options considering all the aspects discussed.