Equity or debt, SIP or lumpsum, mid-cap or large-cap – mutual fund investors have to make several decisions. One such choice that they often come across is whether to go for growth or dividend option. These are not two diverse schemes; in fact, they invest in the same set of stocks and have a similar objective. However, their NAVs are different and the way returns are distributed also varies. Hence, it becomes crucial to understand the difference.
In growth option, there is no immediate or short-term return. The return or appreciation on the fund value is reinvested right back into the fund to buy more units. If the investor has long term financial goals and does not need return from the fund or income flow in the near future, then this option is best suited as it results in high returns due to the benefit of compounding as returns which otherwise would have been distributed as dividends get ploughed back in the scheme.
* The benefit of compounding leads to higher appreciation.
* It`s ideal for long term investment goals like retirement planning, children’s education, etc.
* Profits made by the scheme are reinvested back into it and hence, the returns are compounded. This results in higher proceeds on time of maturity..
* The investor does not receive any income in hand unless he chooses to redeem the units.
* It is all or none kind of a deal as there is no recovery of profits unless the redemption takes place which makes it quite risky.
Under the dividend option, the profit that the fund earns is not re-invested but rather disbursed amongst investors in the form of dividend. This option is ideal for those who are looking for regular income from the fund to supplement the existing income sources. This option works best when the markets are on an upswing as it increases the chance of fund declaring a dividend.
* There is no need to redeem units for generating income in case of dividend option.
* The risk is partially mitigated if the dividend is disbursed as the investor is able to recover some part of the investment without dissolving the entire investment.
* Since profits are paid out at periodic intervals, there is no benefit of compounding.
* There is no regularity or guarantee of dividend payouts. Dividends are paid only when there is profit.
* Over a period of time, the NAV can get shaved off owing to maintenance charges and regular dividend distribution.
Taxability of returns
In case of dividend option, the entire dividend declared on equity funds is free of tax. However, the dividend declared on debt funds is taxed. On the other hand, profit on growth funds attracts short term capital gains tax if the units are redeemed within one year of purchase. Beyond one year, all proceeds are tax free.
Which option is better?
As any investment expert would say, the decision really depends on the individual’s financial goals. If the investor has a long-term horizon and a steady stream of income, it would be advisable to go for growth option. If an investor is looking at mutual funds to earn regular income or is in his retirement years, dividend option makes more sense. However, the best way to go about planning investment in mutual funds is to stick to your goals and choose the best option which will help you achieve them the earliest.