There are different categories to select from when it comes to mutual fund investment. After investing in any mutual fund, the fund manager invests your money in equity, debt, and other money market instruments. The categories include equity large-cap, equity midcap, liquid funds, debt and thematic funds.
However, before considering investing in any of these categories, it is crucial to understand the type of mutual funds you as an investor want.
Mutual Funds offer two types of options – growth mutual fund and dividend mutual fund. There are a lot of misconceptions about these options among investors.
Growth Mutual Fund
Growth mutual funds are more popular among investors. The income that is generated by the fund is reinvested or held in cash in order to invest later. Since the profits are reinvested in the scheme, the investor can earn profits on profit and hence benefit from compounding.
Growth mutual funds have one considerable advantage over dividend mutual funds: compounding.
Each time the investments of a growth mutual fund that makes money, it is reinvested. This cycle continues to the point the investor decides to pull out. A considerable period of time, growth Mutual Funds can work wonders for the investor’s money. However, this requires a lot of patience. In case the investor is dependent on this money, they will have to sell units of the mutual funds on their own. This will reduce the amount that has been invested and therefore, the effect of compounding is hampered.
Growth mutual funds are subject to tax on redemption. The investor will not be charged any tax until they take out money from the Mutual Fund. In the case of most equity mutual funds, if the investment is redeemed after a year, the investor does not have to pay any tax. For most debt funds, there is no tax liability after a period of three years.
Dividend Mutual Fund
Dividend Mutual Funds are a little different from growth mutual funds. The key difference is that dividend mutual funds pay dividends to the investors. However, it is important to note that these divisions are not fixed.
The amount and frequency of dividend that is to be paid are left to the discretion of the fund manager. The frequency that is most common is quarterly and monthly.
Dividend mutual funds of a regular dividend that are decided by the fund managers. Dividend Mutual Funds take a bit longer to show the same results as a growth mutual fund does. However, one of the major advantages dividend Mutual Funds have is that they start paying back quicker. It provides a certain peace of mind to the investors.
Dividend mutual funds are taxed a little differently. The investor does not have to pay any tax when receiving the dividend. However, the taxes paid by the mutual fund houses even before the dividend reaches the investor. Therefore, dividend Mutual Funds are not very tax efficient.
In case the investor requires a fixed income and has a large amount of money to invest, they should consider investing using the Systematic Withdrawal Plan or SWP option.