Growth or Dividend Option in Mutual funds?
Growth or Dividend Option in Mutual Funds?
When selecting a mutual fund, investors encounter a wide array of choices, including one that often baffles them: the decision between a fund with a growth option and one with a dividend reinvestment option.
Both types of funds come with their own sets of advantages and disadvantages, and the choice between them depends on the unique financial needs and circumstances of each investor.
There's no one-size-fits-all solution in mutual funds. That's why there are so many options available. Before investing in a mutual fund, it's essential to carefully review all the fund's details to ensure it aligns with your individual goals for growth or income.
In the growth option of a mutual fund scheme, all profits generated by the fund are reinvested into the scheme. Consequently, the Net Asset Value (NAV) increases over time, compounding your principal investment. This is akin to the cumulative option in a bank fixed deposit, where interest is reinvested, leading to exponential growth over time. Investors must redeem units to realize the growth in the value of their investments.
Investments under the growth option do not provide short-term income; the money remains invested until redemption, resulting in capital appreciation and returns. For instance, if you bought 1,000 units of a mutual fund at Rs. 11 and sold them a year later at Rs. 15, the Rs. 4,000 difference (Rs. 15 - 11 = Rs. 4 * 1,000 units = Rs. 4,000) represents your capital gain and return on investment.
This investment style is better suited for long-term equity mutual fund investments, as long-term capital gains are tax-free. While equity mutual funds carry short-term risks, they typically deliver robust returns over the long term. The growth option capitalizes on the power of compounding, as both the principal and notional profits contribute to the fund's growth. It's a smart choice for investors not relying on monthly income from their investments.
Furthermore, since the fund does not distribute dividends, the NAV is generally higher than that of the dividend option for the same fund, although this difference arises solely from dividend payments, not substantial differences in fund performance.
In the dividend option of a mutual fund scheme, profits are periodically distributed to unit holders. Investors should opt for the dividend option if they expect regular income from their investment without having to redeem any units.
It's important to note that dividends aren't guaranteed, and there are instances when no dividends are declared during the year if the fund or market performance does not justify them.
In debt funds, the asset management company (AMC) withholds a dividend distribution tax (DDT) on the investor's behalf and then pays the dividend to the investor. Consequently, the dividend option in debt funds is not typically recommended.
DIVIDEND REINVESTMENT OPTION
This option attempts to combine the best of both worlds by declaring dividends to investors but reinvesting those dividends back into the same mutual fund for additional units. In the case of ELSS (Equity-Linked Savings Schemes), the new units are subject to a 3-year lock-in period. Nevertheless, the growth option is often a superior choice compared to the dividend reinvestment option.
The choice among these three options should primarily align with your cash flow requirements. If you don't need periodic liquidity, the growth option is suitable. The returns in the growth option are reflected in the scheme's NAV. Conversely, if you require regular cash flows, choose the dividend option.
Sneha Ramamurthy
Content Strategist at Dilzer Consultants