If you are a new to mutual funds, then you might get confused between, whether to invest in growth option or dividend option. And, selecting the right option is very important for you as is selecting the right fund. Because it can cause huge variations in returns plus, you can miss the chance to accomplish the investment objective.
So, it becomes very important for you to understand the difference between Growth Option and Dividend Option, and when you should select which option. Now, we will understand it in detail.
A fund with dividend option allows investors to receive returns at periodic intervals in the form of dividends. The amount of dividend and intervals are not fixed and is decided by the fund house depending on the fund’s performance.
Under the dividend option, the NAV of the fund moves very little, as the dividend amount is paid by redeeming equivalent units of the scheme. After every payout of dividend, the NAV of the fund is deducted by the amount of dividend paid to investors.
For example, if the NAV of the fund’s dividend option is Rs 18, and the fund manager declares a dividend of Rs 3, so, after the dividend is paid to investors, the NAV of the fund will fall to Rs 15.
Mutual fund dividends are different from stock dividends, as the later represents part of profit paid to equity shareholders. But mutual fund dividends doesn’t represent profitability, or, a high dividend doesn’t mean the fund is performing exceptionally well.
Under the growth option, profits made on the scheme are not paid in the form of dividends or bonuses, but it gets accumulated. The only way to get back the profits is by selling your investments. For the reason, you will see there is a huge difference between the NAV of growth option and dividend option.
The growth option works like any other stock in the market, as its NAV rises when the value of the fund’s portfolio rises and falls when the value of the portfolio registers a decline.
Why Mutual Funds have Two Options?
Mutual Funds serve to a very large user base, and everyone has a different requirement and investment goal set. By offering multiple variations in mutual funds, AMCs are able to serve to a large user-base and allows investors to make a choice based on their investment goals and needs.
When to Select Dividend Option and when Growth Option?
Dividend Options are best suited for short term investments and when the market is trading at an all-time high level, as the probability of declaring a dividend is highest. And, if you are dependent on regular income from your investments, then dividend option should work best for you, but you will lose the benefit of compounding.
Whereas, growth option is very well suited for long term investments as it is aided by the process of compounding.
How Both Options are Taxed?
Both options have different tax treatment.
The dividends received are usually tax-free in the hands of investors, but dividend distribution tax (DDT) of 10 per cent on equity-oriented funds is deducted by the fund houses before paying to investors.
While long term capital gains of over Rs 1 Lakh in mutual funds with growth options are taxed at the rate of 10 per cent. And, short term capital gains (less than 1 year) are taxed at a flat rate of 15 per cent.
As you can see, the dividend option of mutual funds are very ineffective for long term wealth creation, but it suits those investors, who are looking for shorter duration investments, preferably less than 1 year and regular income. Further, there is no fixed timeline and rate of dividend under the dividend option, which makes it less attractive for investors.
Whereas, investments in growth option are well suited for long term investing (5 yrs & more), and its performance can also be tracked very easily.