Mutual funds offer two broad types of options – Growth and Dividend. There are several misconceptions about these options among lay investors. In the debate of growth vs dividend, some think growth option is better while others think that, dividend option is better. One option is not necessarily better than other. You should select the option which is more suited to your investment needs viz. financial objective and tax situation. In this article, we will discuss the difference between growth and dividend options and how they work.
Before you endeavour how to choose mutual funds, you must know the following 3 things -
In dividend option, profits made by the mutual fund scheme are paid out to investors at certain intervals. The most common dividend pay-out interval is annual. However, some schemes also offer other pay-out intervals e.g. daily, monthly, quarterly etc. Some schemes may offer multiple pay-out options. One type of dividend option is dividend re-investment option, whereby dividends paid by the scheme are re-invested in the scheme. Here are some important points to note about dividend option:-
In growth option, profits made by the scheme are re-invested in the scheme instead of being paid out to investors. Since profits are re-invested in the scheme, you may earn profits on profit and thereby benefit from compounding. If you think, growth vs dividend, you should invest in growth option if you do not need regular cash-flows. Here are some important points to note about growth option:-
|Profits booked by fund manager
|Distributed to investors
|Re-invested in the scheme
|Net Asset Value (NAV)
|Dividends paid are deducted from the NAV. So ex-dividend NAV is lower
|NAV will be higher because profits re-invested may earn profits (compounding)
|Total returns will be lower compared to growth option in the long term due to periodic payouts
|Total returns will usually be higher compared to dividend option over sufficiently long investment horizon
|Taxed as per the income tax slab rate of the investor
|Short term and long term capital gains tax applies depending on when you redeem
|Who should invest
|If you need regular cash-flows from your investment then you can invest in dividend option
|If you do not need regular cash-flows, invest in growth option since your total returns may be higher
We discussed how growth vs dividend works in mutual funds. We tried to clarify some difference between dividend and growth Even though the underlying portfolio of both the options are same, the only difference is in how the profit is distributed or re-invested. From a taxation standpoint, growth option definitely enjoys tax advantage especially over longer investment tenures. You should consider your tax situation when you select between the growth or the dividend option.
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