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Growth or Dividend Reinvestment Option: Which is better for you?

8 Mins 28 Mar 2023 0 COMMENT

What does the growth option in mutual funds mean?

The term "growth option" refers to an investment strategy in which the profits made by your scheme are re-invested rather than paid out to you. The scheme provides you with a type of compounding benefit, as you get the opportunity to earn profits on the previous profits. This investment strategy is the most effective way to increase your fund's net asset value (NAV). The growth option allows you to book the capital gain amount on redemption.

This type of investment plan is best for you if you want a corpus to meet future goals rather than a regular income.

How does the growth option works?

Suppose you purchase 1000 units of the XYZ mutual fund scheme at a NAV of Rs 50. After a year, the NAV had risen to Rs 60. If you sell your units in this case, you will receive a total of Rs 60,000, with a profit of Rs 10,000. However, if you stay invested and the fund performs well in the coming year, your NAV will rise even more.

What does the dividend reinvestment option mean in mutual funds?

The only similarity between the growth and dividend reinvestment options is that you will not receive cash before redemption in either case. In the dividend reinvestment strategy, the dividend that is normally paid out to investors is instead reinvested in the scheme to buy more units. Choosing this strategy leads to an increase in the number of units held over time. If the market is favourable and the prices of the shares in your portfolio rise, the scheme's value rises as well.

How does the dividend reinvestment option work?

Suppose you invest Rs 1,00,000 in XYZ mutual fund scheme, with a NAV of Rs 10 per unit. The total number of units that you will receive here is 10,000. 

Following your investment, the market performed exceptionally well, and your scheme's NAV increased to Rs 15 in a year with a dividend declaration of Rs 3 per unit.

In this case, the dividend is Rs 30,000, and the value of your dividend reinvestment plan is reduced to the extent the dividend is swiped out. It means your new NAV will be Rs 12.

The dividend of Rs 30,000 will now be reinvested, and the new units you will receive here would be 2,500 (30,000 ÷ 12). In this case, the dividend reinvestment plan increases your scheme's total units to 12,500 after reinvestment. Your investment will now be worth Rs 1,50,000. (12,500 units x Rs. 12)

Dividend reinvestment vs growth option in mutual funds

After going through the above definitions, it should be clear that both of these investment options do not pay out dividends but rather reinvest them. So, what’s the main distinction here? The answer lies in the next table. 

 

Parameters

Dividend Reinvestment Option

Growth Option

Meaning

Before reinvesting, the fund house declares the profit/dividend that you earned on your investment

The fund managers automatically reinvest the profits you make on your investment

Units

The profit is used to purchase more  units 

Instead of buying new units, the profit is reinvested for compounding benefits

Net Asset Value

The mutual fund’s NAV decreases to the level the dividend is declared

As there is no dividend payout, the net asset value doesn’t change because of dividend

Suitability

It is ideal for you if you seek to stay invested for a longer period  

It is ideal if you are looking to build a corpus to meet long-term aspirations and fall into a higher tax bracket. Dividend income is taxable and will be taxed as per the IT slab applicable to investor but capital gain tax rates would generally be lower than tax rate on dividend income.

 

To conclude

The mutual fund house reinvests the dividend in both investment options, but in different ways. In case you prefer long-term investments and want to build wealth through compounding, you should consider a growth strategy.

 

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