Growth Option or Dividend Option – Which is Better for Your Mutual Funds

While choosing a best mutual fund, an individual has to make a number of choices. Many people get confused while investing in mutual funds between the fund with Growth option or Dividend Option and what is their significance. Both these options have its advantages and disadvantages, and deciding which is a better fit will directly depend on your needs and circumstances as an investor. In this post, we will explore more about what Option you should choose while selecting the mutual fund.

Mutual Fund Options

Growth or Dividend Option (Image courtesy of lovelyday16 at FreeDigitalPhotos.net)

Many experts say that “Selecting the right mutual fund option is as important as selecting the mutual fund itself.”

You must have noticed the same mutual fund having two different options; Growth and Dividend (generally they are suffixed as (G) or (D)).

Mutual Fund Options

Mutual Fund Option Variation – Growth & Dividend Option

Their NAVs are different and NAVs of growth option is more than dividend options. Does that mean they are two different schemes? The answer is No. The particular scheme invests in the same stocks or portfolio the only difference is the nature of distribution of profit. Rest of the things such as performance, investment strategy, objective, and fund manager remains the same, but only the way your returns are given is different.

Let’s see what options we have & their important information

There are three options available for investors to choose from, each having a huge impact on your investment goal.

  1. Growth
  2. Dividend
  3. Dividend- reinvestment

Growth –

The growth option means that the profits you make on your capital are reinvested. This reinvestment gives compounding benefit to the investor, providing excellent returns at the end of the term. This reinvestment of the profit increases the net asset value (NAV) of the mutual fund.

Growth Option Under this growth option, the investor will not get any returns in between investment term. Also, the investor will not get any payments in the form of interest, gains, dividends, bonus, etc.

Let us take an example to understand how this works. If you have bought ten units of a mutual fund scheme at a NAV of Rs 10 and you sold those units after 5 years when the NAV of fund had reached Rs 15. So for your Rs 100 investment, returns will be Rs 150.

Dividend –

Dividend payout option means that a part of the profits made by the mutual fund scheme is stripped from NAV of the fund and given to unit holders from time to time. That means, a part of the fund’s profit is given in cash. Hence, your NAV falls to the extent of dividends. This is why the NAV of growth and dividend option are not the same.

Under this dividend option, you will receive returns at periodic intervals. On the other hand, the intervals are not certain, and the dividend amount is also not fixed.

Let’s see this with an example, if you have invested in a mutual fund at the NAV of Rs 10 and opted for dividend option. The scheme performs and NAV reaches to Rs 14. The fund decides to pay out Rs 2 as a dividend. So you receive cash Rs 1.50 and at the same time the NAV will fall back to Rs 12.

Dividend Re-investment –

In dividend reinvestment option too, profits are stripped (just like dividend option). But the difference is instead of giving them as cash; they are allotted to investors as units at the prevailing NAV. Hence, indirectly, by adding more units, the investor simply stay invested in the fund. Conceptually, the dividend reinvestment & Growth options are same for all equity mutual funds.

See: How to Invest in Mutual Funds

Which option to choose?

Most people take their decisions on tax efficiency. While it is a key deciding criterion, let us also look at how different factors too, will play a role in picking between dividend and growth.

Two key factors will decide what is appropriate option is for you between Growth option or Dividend Option –

  1. Cash requirement and time frame
  2. Tax efficiency

Long term – For equity mutual funds – Equity mutual funds are meant for long term. The main reason for choosing an equity mutual fund must be to create wealth or tax saving while getting equity return in the long term. This just means that you should stay invested & do not take the cash out, to help compounding work for your investment. Wealth is created only if you let it compound since long-term capital gains are tax-free. As a rule of thumb, go for growth or dividend reinvestment in equity funds.

When you prefer growth option, the returns in tax phraseology is called as capital gains. The capital gains in growth option of the equity mutual funds are not taxable. But in case you sell the units within 1 year you will have to pay short-term capital gains tax.

Short Term – Debt Mutual Funds – If you have a lot of cash on hand for a near future & you want to gain more out of it then debt mutual funds will suit the best. For short-term (less than 1 year) investments in debt funds, I would recommend you to go to dividend option or dividend re-investment option, primarily on tax considerations. Though dividends are tax-free in the hands of investors, the fund has to pay DDT (dividend distribution tax) of 12.5% before it pays you. If you go for the growth option, the returns will be viewed as short-term capital gains, for which you may have to pay at the marginal tax rate per your tax slab. So if you come under 30 percent tax bracket, then you will end up paying lesser rate if you choose dividend option in debt mutual funds.

Mid Term – For mid-term (more than 1 year & less than 4 years) investments in debt mutual funds, you should opt for growth option, as the capital gains tax, in this case, will be 10% without indexation or 20% with indexation, which is more likely to be less than marginal tax rate.

Summary:

No single mutual fund is ideal for every investor; that’s why there are many funds out there with so many various options. When investing in a mutual fund, it’s best to check all of the particulars of the fund, to bypass investing in a fund that doesn’t suit your goal. Here are three options I think you should keep in mind before investing.

Long-term needs (5 – 7 yrs or more): Equity mutual funds with growth option.
Short-term needs (less than 1 year): Debt mutual funds with dividend option or dividend re-investment option.
Mid-term needs (more than 1 year to 4 years): Debt mutual funds with growth option.

2 Replies

Trackback  •  Comments RSS

  1. Shrikant says:

    Very nice information. This helps a lot to choose an option for short term and long term investment

Post a Reply

Your email address will not be published. Required fields are marked *

Top