Mutual Funds offer three options to an investor: Dividend, Dividend Reinvestment and Growth. Last time we considered the pros and cons of choosing the Dividend option. (Check out - Growth or Dividend - How to make the right choice?)

To recap
Dividend money not utilized vegetates in the bank, thereby diluting the rate of return. On the other hand, if it has to be re-invested in equity --- then why take it out in the first place? And lastly, all funds pay dividends at their whim and not your fancy. Instead, take matters in your own hands, opt for the growth option and withdraw the non-taxable long-term gains as dividend.

This time lets see what the Dividend Reinvestment option is all about.

Dividend v/s Dividend Reinvestment
Tax policy and tax policy alone should dictate the choice of Dividend Reinvestment option. There is simply no other criterion.

Let's see why. Again, let's take the example of Franklin India Prima, a scheme that has been in existence, in one form or another, since November 1993. At the time of writing this, the NAV of Prima Growth option is Rs. 155.10 whereas that of the Dividend option is Rs. 49.39. Notice that there is no separate NAV declared for the Dividend Reinvestment option. Why is this?

The reason is simple. As far as NAV is concerned, there is no difference between the Dividend option and the Dividend Reinvestment option. In other words, the NAV of the Dividend option of Prima would also apply to the Dividend Reinvestment option.

How does the Dividend Reinvestment option work?
This is because, under the Reinvestment option, instead of actually physically receiving the dividend in your bank, the Mutual Fund itself ploughs it back at source by allotting additional units in the scheme to the investor. In fact, you could have done the same…after having received the dividend; you could have cut a cheque to invest the dividend amount into the scheme. Since this is done at source, the only difference between the Dividend option and the Reinvestment option is the time saved in the latter. Of course, there is no entry load imposed but that's not the point here.

The problem with receiving the money and then investing it is that often times, the money lies in the bank but you just haven't got down to actually investing it. Each day that passes dilutes the return on your investment. The other problem is our innate psychology…just then if the market is volatile, you may defer the decision of committing money and again on an overall perspective, the return suffers. With dividend reinvestment, there is a kind of enforced discipline…since the MF is doing it on your behalf, you take away the discretion element from the equation. Then isn't this the best option to choose?

contd on Page 2...