Growth Mutual Fund vs. Dividend Mutual Fund
There are various types of mutual funds to invest in. When you invest in any mutual fund, the fund manager invests your money in equity, debt, and other money market instruments.
These funds are categorised into equity large-cap, debt, equity midcap, liquid funds, and thematic funds. But before considering investing in any of these categories, it is crucial to understand the type of mutual funds (MFs) you, as an investor, want.
Every mutual fund scheme is divided into two types: growth and dividend. The growth option provides returns by increasing mutual fund unit values. On the other hand, the dividend option pays out returns in the form of periodic dividends.
What are Growth Mutual Funds?
The growth option on a mutual fund indicates that an investor will not get any dividends from the mutual fund's stocks.
Certain shares offer monthly dividends, but by opting for the growth option, the fund holder allows the fund company to reinvest the money that would otherwise be sent to the investor as a dividend. This money raises the mutual fund's net asset value (NAV).
The growth option is not suitable for investors who want regular cash payments from their assets.
Some of the key points to remember are:
- The underlying portfolio will remain the same, and profits will be re-invested in the mutual fund scheme instead of paying dividends to investors.
- The NAV of the mutual fund units rise over time as the reinvested profits grow in value.
- Total returns from growth mutual funds can be higher over a long investment horizon, primarily due to the compounding effect.
- Taxation will come into effect only when the investor redeems the mutual fund units. Gains made on the sale of equity funds held for less than 12 months incur a short-term capital gains tax of 15%. For gains made on the sale of units held for longer than 12 months, long-term capital gains tax is charged at the rate of 10%. Long-term capital gains of up to Rs 1 lakh are exempt from tax; the remaining gains are taxed.
- For debt funds, when mutual fund units are held for less than 36 months, short-term capital gains are taxed based on the income tax slab rate of the investor. Similarly, mutual funds held for over 36 months are taxed at 20% after indexation benefits.
What are Dividend Mutual Funds?
The dividend reinvestment option is unique. Dividends that would otherwise be paid to fund investors are utilised to buy more fund shares. When dividends are paid on the stocks in the mutual fund, funds do not return to the investor.
Instead, fund managers utilise funds automatically to purchase additional fund units on behalf of investors and transfer them to individual investors' accounts.
This strategy gradually raises the number of shares owned and often results in the account increasing value faster than if dividends were not reinvested.
Moreover, many investing firms provide this service at no cost to shareholders.
Some of the key points to remember here are:
- Dividends are paid from the scheme's accumulated profits.
- Mutual fund houses cannot guarantee dividend pay-out rates or timing.
- The NAV of the mutual fund units is adjusted based on the dividends paid to the investors. After receiving dividends, investors will notice a decline in NAV. If investors choose the dividend reinvestment option here, the number of units held under the scheme will increase.
- For dividends received from mutual funds, investors would need to pay income tax based on the slab rate for both equity and debt mutual funds. Also, a tax deduction at source (TDS) of 10% applies for dividend income if the aggregate dividend distributed during a financial year to an individual unitholder exceeds Rs 5,000. A TDS rate of 20% applies if there is no PAN number.
Difference Between Growth and Dividend Mutual Funds
Here is an overview of the difference between Dividend vs Growth Mutual Funds based on various factors-
|
Differences |
Dividend Mutual Funds |
Growth Mutual Funds |
|
Profits booked by the fund manager |
Distributed among investors |
Reinvested in the scheme |
|
Total Returns |
Dividends are subtracted from the NAV. As a result, the ex-dividend NAV is lower. |
Because profits re-invested may earn profits, the NAV will rise (compounding) |
|
Net Asset Value (NAV) |
Due to periodic payouts, total profits will be lower compared to the growth option in the long run. |
Over a suitably long investment horizon, total returns are usually larger than dividend returns. |
|
Taxation |
Taxed at the investor's income tax slab rate |
When redeeming, you may be subject to short-term and long-term capital gains tax. |
|
Who should invest? |
Consider the dividend option if you require steady income flows from your investment. |
If you do not require a steady income flow, invest in the growth option because your overall returns may be higher. |
Why Growth Mutual Fund?
Growth mutual funds have one very considerable advantage over dividend mutual funds: compounding. Every time the investments of a growth mutual fund make money, it is reinvested. This cycle continues until the point you, as an investor, decide to pull out.
Over an extended period, growth mutual funds can work wonders for your money. However, this requires patience. If you depend on this money, you will have to sell units of your mutual fund. That will reduce the amount you have invested.
Since the amount you have invested is reduced, the effect of compounding could be improved.
Why Dividend Mutual Funds?
Dividend mutual funds offer regular dividends that the fund managers decide.
Dividend mutual funds take longer to show the same results as a growth mutual fund. However, one significant advantage dividend mutual funds have is that they start paying back much more quickly.
It offers investors a certain peace of mind. However, confident investors would trade peace of mind for higher returns, and dividend mutual funds suit them best.
Tax Implications on Growth Vs Dividend Mutual Funds
Growth mutual funds are subject to tax on redemption. However, you are only charged tax once you withdraw money from a mutual fund.
For most equity mutual funds, you do not have to pay any taxes if the investment is redeemed after a year. For most debt funds, there is no tax liability after three years.
Dividend mutual funds are taxed differently. You do not have to pay any taxes upon receiving your dividend. However, the tax is paid by the mutual fund houses even before the dividend reaches you. So, in that sense, dividend mutual funds could be more tax-efficient.
If you require a fixed income and have a large amount of money, consider investing using the SWP (Systematic Withdrawal Plan) option.
Conclusion
No single mutual fund is ideal for every investor, which is why so many options are available.
Investing in a mutual fund is best to investigate its specific characteristics to prevent investing in a fund that does not meet your growth or cash payout needs.
Happy Investing!