Dividend Reinvestments??

I am back to Blogging after almost a year! 

This time I am up with a small post related to investments. I was discussing with my friends and colleagues about where to invest to save tax and we had a discussion around various options available to invest under section 80c which gives tax breaks.

The only option which has the smallest lock-in and Tax free returns is the mutual fund one. However it has a great amount of risk involved in it and there is no capital shield for the money invested in tax saving mutual funds. These mutual funds which gives tax break under section 80C are typically called as Equity Linked Savings Scheme funds (ELSS funds). 

Under ELSS the lock-in period is 3 years and the return is based on the market conditions. Now under ElSS funds there are again various options to consider before diving into these schemes.

• Growth or Dividend?

The major difference between these two schemes is that the dividend funds declare some x percent dividends annually whereas growth options doesn't.

I think it makes sense to go for dividend funds, because these funds declare dividends each year which directly come into the investor's hand (Dividends declared by ELSS funds are tax free). This dividend is generally declared in the month of Feb/March. By investing in dividend funds we get the money back sooner than growth funds. Now the other part of the story is this is the same money which you have invested and when these funds declare dividends the NAV of the fund falls accordingly. The only good thing is you get your money back soon.

• Dividend Payout or Dividend Reinvestment

A word of caution! When investing in ELSS funds never go in for a Dividend Reinvestment plan. The name itself makes it very clear that what these funds do with the dividends. The dividend which is declared by the fund is again put into the same fund and you get some more units.By opting for this you go into a never ending vicious cycle of dividends reinvestments and you can never redeem all of your money(Some part of your investment will always be stuck with the fund, because every time it reinvests your money, those units get locked-in for 3 years).

The lock-in is only for ELSS funds so there is no harm in going for Dividend Reinvestment if you are investing in a fund other than ELSS because in that case you can anytime redeem your whole units.

For ELLS funds, if you want to go for dividends take a Dividend Payout plan which will give you dividends in your hands. One strategy to maximize the tax gain is to invest in a Dividend payout ELSS fund and then reinvest the dividend part again in a ELSS scheme so that you can again claim that part also under 80c! This is exactly what Dividend Reinvestment plan does(But it does implicitly and every year without giving the user an option). Dividend payout gives the money back to the user so he himself can decide whether he wants to put that money back in the fund or keep it with him.

Happy Investing!