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growth and dividend reinvestment in mutual fund

We all wish to make money, isn’t it? Mutual Funds are thus one of the most popular avenues to generate good returns. Subsequently, they come with a variety of options like growth options, dividend options, and dividend-reinvestment options. In the following analysis, we discuss the growth vs dividend reinvestment option in mutual funds and its benefits. Let’s begin!

What is the Growth option?

Some mutual funds also come with a growth option. This means that the investors will not receive the profits that the fund may generate subsequently. Instead, the investor has allowed the fund house to re-invest their money, which otherwise would have been given to the investor. This increases the net asset value of the fund as well as the number of shares remain the same.

This, however, is not a good option for those who are looking to get regular pay-outs. Subsequently, this is a way to increase the NAV of the fund.

Moreover, the maturity amount will be higher for long-term investment. This means that the investor will also make a lot of profit for the same number of shares.

 

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What is the Dividend reinvestment option?

An option is given to the investors whereby they can re-invest the dividends. It is subsequently used to purchase more shares. Also, no cash is paid to the investors at the time of giving dividends. Instead, the fund manager buys more shares in the fund and transfers them into their individual accounts.

As the number of shares increases, the account’s value increases as well in comparison to when the dividends being paid. However, the NAV comes down. This option also attracts DDT and thus is preferred for investors who pay higher taxes.

Growth vs Dividend reinvestment difference

Both options might look the same as they generate profits. However, they are very different from each other. In the growth option, the profit is directly reinvested while it is reinvested as a dividend in the dividend reinvestment option.

The reinvestment of dividends earlier used to attract a Dividend distribution tax(DDT) of 28.84%. Thus, this is now to be paid individually by the investor and not the fund house as per the budget 2020.  Growth and Dividend reinvestment option in mutual fund is an important characteristic of any mutual fund scheme.

Growth Plan

 

ParticularGrowth Plan
Units bough (As on April 1, 2020)1000
NAV10
Total investment in Rs10,000
NAV as on 30-6-2012
Value of investment12,000
DividendN.A.
Dividend paymentN.A.
Dividend re-investedN.A.
NAV post dividend15
Post Dividend Value15,000

 

Dividend reinvestment plan

 

ParticularDividend Reinvestment Plan
Units bought (Jan 1, 2020)1000
NAV10
Total value in Rs10,000
Dividend as on April 1, 20202
NAV as on April 1, 202013
Dividend paid as on April 1, 20200
Dividend reinvested as on April 1,20202000 (2x1000)
Additional units as on April 1, 2020153.84 (2000/13)
Total units as on April 1, 20201153.84
Dividend as on July 1,20201.5
NAV as on July 1, 202015
Dividend paid as on July 1, 20200
Dividend reinvested as on July 1,20201730.76
Additional Units as on July 1, 2020115.38
Total units as July 1,20201269.22

 

growth vs dividend reinvestment

When should you prefer the growth option?

The following cases are suitable for choosing the growth option in mutual funds,

1. Long-term equity investment: Investors who are thus looking for long-term capital appreciation should go for the growth plan. It is because the compounding benefit extended to the investors in this situation will be much higher in comparison to the dividend reinvestment scheme. Moreover, the DDT is also a factor in dividend reinvestment which can lower the returns.

2. Low tax groups: Those investors who thus come in the income-tax bracket of 10% and 20% and subsequently paying a 28.84% DDT will not be ideal.

3. Short-term debt investment: Furthermore, investors who are planning to invest in debt funds(fixed income instruments), will be taxed on the returns. Thus, for those investors who are in the lower income-tax slab, subsequently, the net reduction from the tax will also be lower. They can subsequently go for the growth option.

When should you prefer the dividend reinvestment option?

The following cases validate the choice of dividend-reinvestment funds,

1. Short-term liquid investments: Investors who are thus looking to invest in liquid funds for a very short period, should go for the dividend reinvestment option. This is because this option pays dividends on a daily or weekly basis.

2. Higher-taxation group: Moreover, Investors who are in the 30% tax slab, should go for this option.

3. Investors in high tax slabs and looking to invest in debt funds: This investment also attracts taxes. Thus, those investors in the 30% tax slab should avail of this as they pay only 28.84% and not 30%.

Consequently, fund houses declare the profits from time to time, in the form of dividends. However, under the dividend reinvestment option, this is not transferred as a pay-out to the investor. Instead, it is used to purchase more shares. This subsequently leads to a fall in the net asset value of the fund. Thus, the net share of the fund increases.

growth vs dividend reinvestment

Do these options work?

We come to the most important question on this issue. Does it help by going for these options? If you are indeed an investor who falls in the lower income tax slab and are looking to invest for the long term, you should choose the growth option. On the contrary, if you are an investor who comes under a higher tax slab and is looking to invest for a short time, you should go for the dividend reinvestment option.

Furthermore, each option has its pros and cons. Investors will also have to make a choice depending on their financial goals and outlook. Moreover, investors might be surprised if the schemes are the same or different. The mutual fund scheme is the same while the profit distribution is different.

How to Switch From Dividend to Growth Option?

Yes. It is indeed possible to switch from a dividend reinvestment option to a growth option and vice-versa. It would then comprise a sale of old units and the purchase of new units. However, it would be subject to an exit load and other taxes. Investors should clarify these aspects of the investment with an investment & tax consultant before going ahead. Growth and dividend reinvestment options offer a variety of choices for investors with a varying outlook.

Conclusion

Mutual fund schemes come with two options, namely, growth option and dividend reinvestment option. Also, the scheme remains the same. Furthermore, the manner in which the profit gets distributed changes. In the growth option, the profit is paid out while in the dividend reinvestment option, the dividends so generated get reinvested and more shares are purchased. There is a difference in the NAV of both these options due to the compounding effect. Investors should understand the difference between the two options and the taxation before making a choice vis a vis growth vs dividend reinvestment. Happy investing!

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