In this blog, we walk you through the characteristics of Growth and Dividend Option in Mutual Fund.
Most mutual fund plans come in two varieties: growth and dividend. Dividend plans, as opposed to growth plans, are those in which mutual fund investors receive regular dividends at the discretion of the asset management company.
Under a dividend option, profits made by the mutual fund scheme are paid out to investors at certain intervals (in the form of a dividend). The most common interval is annual. However, certain schemes could also offer other pay-out intervals e.g. daily, monthly, quarterly, etc.
Moreover, despite the intervals set in any mutual fund scheme, there is no fixed assurance about the dividend pay-out rate or timing of such payments. It may vary depending upon the overall performance of a mutual fund.
The dividend paid to investors is adjusted from the scheme’s NAV. Hence, you will see a drop in NAV (ex-dividend NAV) of your scheme after you receive a dividend. In other words, the NAV of the mutual fund always decreases by the dividend amount paid out to the investors, and that any re-purchase after the dividend payout date is made at the ex-dividend NAV.
Profits made by a mutual fund scheme are re-invested back into the scheme rather than being paid out to investors when the scheme has a growth option.
Here, the mutual fund does not pay out anything to the investors by way of regular payouts. Rather all the profits made by the fund are reinvested in the fund itself and, therefore, your wealth compounds. Because of this, the NAV increases over time thereby compounding your principal.
As an investor, you will have to redeem the units in the mutual fund to realize the growth potential in the value of the investments.
Example of NAV under dividend and growth option
Assume that you have Rs. 1000 invested respectively with 100 units each in the growth and dividend option. The NAVs of the growth and the dividend options are at Rs. 20 each.
The fund declares a 20% dividend. At a face value of Rs. 10 per unit, the dividend payout will be Rs. 2 per unit held.
Here, your investment in the dividend option will yield a dividend of Rs. 200 (Rs. 2 x 100 units). And the NAV of the dividend option will fall to Rs. 18 (NAV Rs. 20 – Rs. 2 of dividend).
If you redeem all of the units, the investment in the growth option will yield Rs. 2,000 (NAV Rs. 20 x 100 units) while that in dividend option will give you Rs. 1,800 (NAV Rs. 18 x 100 units).
Since you have already taken a dividend of Rs. 200, the total yield from both these investments is the same (Rs. 2,000 in Growth Option & Rs. 1,800 through the redemption of units + Rs. 200 in dividends in Dividend Option).
Difference between Growth and Dividend Option in Mutual Fund
The only difference between growth and dividend options is that profits are re-invested in the growth option while they are distributed in the dividend option.
Also, the NAV of the growth option will always be higher than that of the dividend option.
Moreover, the total value of returns in the growth option is normally more than the dividend option over a sufficiently long investment horizon due to the compounding effect.
The table below shows the differences between the two options:
|Dividend option||Growth option|
|Profits booked by the fund manager are distributed to investors.||Profits booked by the fund manager are re-invested in the scheme.|
|Income in the form of dividends is available to investors.||Investors will only be able to cash out at the end of the scheme or when they sell their units.|
|A dividend is deducted from the NAV.||The number of units you hold remains the same but NAV can vary according to the fund’s performance.|
|Dividends paid are deducted from the NAV. So ex-dividend NAV is lower.||NAV will be higher because profits re-invested may earn further profits.|
|In the long-term, total returns will be lower compared to growth options – due to periodic payouts||Total returns will usually be higher compared to dividend options over a 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|
Example of long-term returns under dividend and growth option
Below is a fictitious example that shows the returns from similar funds with growth and dividend options over 3 years. Suppose an investor invests Rs. 1 lac in a fund where the NAV was Rs. 100 per unit and the number of units allotted is 1,000. How much his investment will be worth after 3 years under the growth and dividend option is shown below:
|Investment of Rs. 1,00,000 |
NAV = Rs. 100 Units = 1,000
|Growth Mutual Fund A||Dividend Mutual Fund B|
|Year 1 Both mutual funds return 50% in year 1: |
B’s dividend = Rs. 20 per unit
|Year 1 NAV = Rs. 150 Units = 1,000 |
Total value on redemption = Rs. 1,50,000
|Year 1 Post dividend NAV = Rs. 130 (150 – 20) |
Dividend pay-out = 20,000
Total value on redemption = Rs. 1,50,000 (130,000 + 20,000)
|Year 2 Both mutual funds return 40% in year 2: |
B’s dividend = Rs. 40 per unit
|Year 2 NAV = Rs. 210 (150+40%) |
Units = 1,000
Total value on redemption = Rs. 2,10,000
|Year 2 NAV before dividend = Rs. 182 (130 + 40%) |
Final NAV post dividend = Rs. 142 (182 – 40)
Dividend pay-out = 40,000
Total value on redemption = Rs. 2,02,000 (1,42,000+20,000+40,000)
|Year 3 Both mutual funds return 100% in year 3: |
B’s dividend = Rs. 30 per unit
|Year 3 NAV = Rs. 420 (210+100%) |
Units = 1,000
Total value on redemption = Rs. 4,20,000
|Year 3 NAV before dividend = Rs. 284 (142 + 100%) |
Final NAV post dividend = Rs. 254 (284 – 30)
Dividend pay-out = 30,000
Total value on redemption = Rs. 3,44,000 (2,54,000+20,000+40,000+30,000)
If the investor chooses a growth option, his investment will be worth Rs. 420,000 at the end of the third year. And the worth of his investment would be Rs. 344,000 if he chooses the dividend option.
Some mutual fund companies also offer another variant of dividend option called the “Dividend reinvestment plan”. In a Dividend reinvestment plan, the investor has an option to reinvest the dividend declared by the mutual fund in the same scheme. The investor purchases more units of the scheme with the amount of dividend payout. In the above example, instead of taking cash dividend, the investor may choose to buy more units at the post dividend NAV, i.e., Rs. 20,000/130 = 154 units. Thus, the total number of units held increase to 1,000 + 154 (1,154) units. And the total value of the investment will be no. of units x post-dividend NAV: 1,154 x Rs 130 = Rs. 150,020. Remember, these calculations are without taking the effect of taxes and are only for the sake of understanding.
Which is better?
One option is not always preferable to another. You should choose the option that is best suited to your investment needs, namely your financial objectives and tax situation.
Who should invest in the dividend option?
If you require consistent cash flow from your investment, then you may consider the dividend option.
Who should invest in the growth option?
If you do not require consistent cash flow, invest in the growth option because your total returns may be higher.
Thus, it can be said that if you rely on your investments for a regular income, the dividend option may be suitable for you. However, because profits are not reinvested in the scheme, you may miss out on the compounding of returns in the long run. When compared to growth options, wealth accumulation may slow down in dividend options.
Thanks for reading!
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