We can have an objective view between growth and dividend option, only after considering the time horizon. Unless you know for how long you want to invest the money, you cannot decide which option is better.

Investment horizon more than 5 years

An equity investment would be preferred if your time horizon is more than 5 years. And you must choose growth option for equity funds. This is because you can make compounding work for you. If you receive regular dividends, you may end up using that money for non-priority things.

Investment horizon between 3-5 years

A combination of debt and equity will work best. You must choose growth option in case of an equity fund. In case of a debt fund, again you must choose growth option which will give you indexation benefit.

Investment horizon between 1-3 years

Post budget 2014, indexation benefit is available to debt funds only after 36 months of investment. In such a situation an arbitrage fund can be used. Arbitrage funds are the panacea for low risk taking investors. These funds capitalize on the market inefficiencies and generate profits for the investors. These funds tax treatment is at par with equity funds i.e. after one year of investment all capital gains are tax-free.

Investment horizon less than 1 year

If your time horizon is less than 1 year and you want a safe investment choice, investing your money in a Fixed Deposit is the best option due to flexibility and ease of investment. However, if you are on highest tax bracket, you must chose ultra-short term debt fund with dividend option. Dividends are completely exempt from tax in the hands of the investor. They are however subject to additional tax on dividends which is paid directly by the mutual fund before it distributes dividends to the investor. In case of dividends distributed by mutual funds, it is called Dividend Distribution Tax (DDT). The rate of DDT is 28.325%. The tax on dividends is paid directly by the company of the mutual fund which declares the dividend. The impact on the investor is that the return would be lower to the extent of the tax so paid. Dividend option in case of a Debt fund would make sense if you are on the highest tax bracket.

Type of Mutual Fund scheme Tax Implication on Dividend received by Unit holders Dividend Distribution Tax (Payable by the Scheme)
Equity Oriented Schemes Unit holder not required to pay taxes Nil
Debt Oriented Schemes Unit holder not required to pay taxes 28.325%