Identifying the right option within the right scheme

As if selection of the right fund house & scheme wasn't hard enough, the investor also has to choose the right option. Here are the typical options

1. Growth

2. Dividend

2.1 Payout

2.1.1 NA (per fund decision)

2.1.2 Yearly

2.1.3 Half-yearly

2.1.4 Quarterly

2.1.5 Weekly

2.2 Reinvestment

2.2.1 NA (per fund decision)

2.2.2 Yearly

2.2.3 Half-yearly

2.2.4 Quarterly

2.2.5 Monthly

2.2.6 Weekly

2.2.7 Daily

3. Bonus (Not very common & I don't know enough about this)

Also note that not all options are available in all fund-schemes. Some are typical in debt funds or liquid funds only. Yet others are for institutional investors only (you can qualify if you are investing in crores, but then you don't need to read these postings).

The unfortunate part is that the offer documents & KIM offer little input in helping the investor choose the right option based on his/her situation. Most of the time, the agent recommends (or selects on their own) one of the options randomly. Even worse, not choosing any of the options or choosing the incorrect combination allows the fund house to use the defaults (as specified in KIM), irrespective of whether it is right for you or not.

Here are some aspects you need to be clear about before you take the next step:

a. Identify if your fund-scheme is a "Equity-Oriented Fund" or not. In case you are not aware, the requirements are that your fund should have 65% invested in "Listed"+"Indian"+"Shares". If you cannot identify this, you should take some time in learning the basics before investing your money in mutual funds.

b. Next determine your need for income. Are you counting on the fund to provide you regular income? Are you looking for predictable or varying amount of income? Are you counting on random income distributions to be treated as "fun-money"? Are you more comfortable with taking your own decisions on withdrawing money from the fund?

c. Finally determine your tax situation. Someone who is below the tax exemption limit needs to choose the options differently vis-as-vis someone in the middle or higher tax brackets to minimise the tax impact. It may be likely that your agent has good intentions but poor competence, which is leading you to pay unnecessary tax at source or as capital gains.

Here are some useful guidelines in helping you select the right option:

a. For Equity-Oriented Funds, typically dividend is declared per fund decision, though some funds typically do it annually. If you are counting on regular steady income, go for growth option and subsequently, opt for SWP with fixed amount (preferably after 1 year of investment to avoid 10% STCG Tax). If you are counting on regular income, though variable, opt for dividend payout from funds who intend to do so annually. This also allows profit booking periodically without paying income tax or STT. For all other cases, simple Growth option is the right choice. DO NOT choose Dividend Reinvestment over Growth in any case. This results in the same portfolio value, but will subject your recent units credited (via investment of dividend) to separate holding period and may result in STCG instead of LTCG (in case you have invested more than a year ago). Choosing this option is the worst any agent can do for you, whether it is done by mistake or stupidity.

b. For Debt-Oriented Funds, your tax situation and duration of investment is a critical decision maker. The fund pays 14% tax on dividends distributed - this is indirectly paid by you as your return is lowered. Just check what is the amount of tax you would pay if you include the entire amount in your income - if it is lower than 14%, you should go for growth option and subsequently, go for SWP or redemption as per your need. If you do not need income from your funds but need to access funds within a year and your marginal tax rate is 20% or more, opt for dividend reinvestment - this will ensure your gains are taxed at a max of 14% instead of your marginal tax rate. In case you intend to invest for more than one year, always opt for growth option (irrespective of your tax status) and then go for SWP or redemption after 1 year. This will ensure that the gains are taxed as LTCG - at 10% rate or 20% (after indexation).

It would be really beneficial if AMFI insists that such basic recommendations are made by the fund houses in the KIM itself so that investors can make the right choice at the right time.