Every investor who invests money in stock market or mutual fund is always confused whether to withdraw dividend from his investment every year or to make long term profit by leaving that money there. On the surface, both the routes seem correct but due to tax rules and compounding, there is a big difference in the final returns from both the options.
Any company and fund house works in two ways. Companies with good cash flow give some part of their profits to their shareholders in the form of dividends. In contrast, growth stock companies increase share prices by reinvesting profits back into the business. Both look attractive but due to tax rules and compounding, there is a huge difference in the results of both.
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Dividend and reinvestment companies
Dividend paying companies are established and stable companies with good cash flow. One problem with this is that there are limited opportunities to grow the business immediately. These companies share a part of their profits with the shareholders. On the contrary, companies doing growth or reinvestment reinvest their profits in new projects or expanding business instead of distributing their profits among shareholders. Due to this, the future earnings of the company increase rapidly, which has a direct impact on the share price.
Why do dividends lag?
First of all, let us understand how beneficial is the dividend received from both the stock market and mutual funds. In the Indian tax system, dividends are treated as income from other sources and are taxed as per income tax slabs. If you fall in the 30% tax slab, a large part of the income goes in tax.
Long Term Capital Gains (LTCG) is taxed if the market remains in the market for more than a year. In this, if you are earning annual profit up to Rs 1.25 lakh then it is tax-free. Apart from this, tax up to 12.5% is levied above that. The most surprising thing is that you have to pay tax on dividends every year. At the same time, tax on capital gains has to be paid only at the time of withdrawal of money. Because of this, your outstanding taxes also continue to earn returns for you.
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What to choose between dividend and growth?
The money received in dividend is not an extra bonus. As the fund makes payments, its per unit share price falls proportionately, meaning a portion of your investment is returned to you. On the contrary, in growth the entire profit of the fund is reinvested in it. Because of this, the price per unit share increases rapidly and one gets the full benefit of compounding.
Every investor should understand that investing does not only mean saving tax. Any decision in this matter should be based on time, risk and financial goals. If you need fixed income and fall in a lower tax slab, then dividends can be a perfect option. Also, if your aim is retirement planning and you fall in a high tax slab, then the growth option can be your better decision.
Note: All the things given in this news are written on general information. If you want to know something about investment then definitely take expert advice.