Growth Vs Dividend Reinvestment Option: Which is Better for You?
Fund houses provide three different options for investment in mutual funds: growth, dividend, and dividend reinvestment. The dividend option is for those seeking regular income, as it pays out dividends periodically. However, the growth and dividend reinvestment options are more suitable for investors aiming to stay invested longer.
While the growth option may seem similar to the dividend reinvestment option, they differ in functionality and tax implications. The following sections include a detailed guide on growth vs dividend reinvestment options.
What is a Growth Option?
In the growth option, investors do not receive dividends from stocks that are held in funds. Instead, the profits or dividends are reinvested into these funds. This increases the Net Asset Value (NAV) of the fund. So, unitholders will gain from the compounding, earning profits on profit. Their investment grows over time without any interim payouts.
The NAV of mutual funds rises while the number of units remains unchanged. So, unitholders get to generate more returns with the same units under this option.
What is a Dividend Reinvestment Option
In the case of dividend reinvestment, dividends declared by mutual funds are utilised to buy more fund units. So, instead of paying out the dividend, the mutual fund purchases more units on behalf of an investor. The unit holder receives more units, which are credited to the account.
The number of units of an investor grows over time with a dividend reinvestment option. So, the value of an investment increases at a rapid rate through compounding. However, the NAV reduces under this investment option as it is adjusted with its dividend.
Differences Between Growth and Dividend Reinvestment Option
The table below gives you a quick comparison between the growth Vs dividend reinvestment option:
Growth Vs Dividend Reinvestment Option |
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|
Aspect |
Growth Option |
Dividend Reinvestment Option |
|
Dividends |
No dividends are paid to investors; all gains are reinvested into the fund. |
Dividends are reinvested to buy additional units for the investor. |
|
NAV Behavior |
NAV increases over time as profits are reinvested, reflecting growth. |
NAV per unit decreases by the dividends declared |
|
Number of Units |
Remains the same throughout the investment period. |
Increases over time as dividends are reinvested to purchase more units. |
|
Compounding Effect |
Growth is achieved through the increase in NAV, which compounds over time. |
Compounding occurs as additional units are purchased and grow in value. |
|
Cash Flow |
No cash payouts; ideal for long-term investors looking to maximise returns. |
No cash payouts; dividends are reinvested, so no regular income is generated. |
|
Suitability |
Suitable for long-term investors aiming for capital appreciation. |
Suitable for investors who want to reinvest dividends to increase their holdings and returns. |
|
Taxation |
Taxed only at the time of redemption based on capital gains (short or long term). |
Each reinvested dividend is treated as a fresh investment, affecting tax calculations at redemption. |
|
Investment Growth |
The value increases through NAV appreciation without changing the number of units. |
Investment value grows through increased NAV and additional units over time. |
|
Exit Load and Lock-in |
Exit load or lock-in (if any) applies based on fund type and redemption time. |
Exit load or lock-in (if any) applies similarly, but each reinvested unit may have its own timeline. |
|
Best For |
Investors focused on maximizing returns through capital gains. |
Investors interested in growing their unit count through reinvestment and compounding benefits. |
Here’s an example to help investors have a clear understanding.
Let’s say an individual invested Rs. 50,000 in a scheme with an NAV of Rs. 10 per unit. He would receive 5,000 units.
Suppose the NAV increased to Rs. 15 per unit after a year with a dividend of Rs. 2 per unit. The dividend amount will stand at Rs. 10,000 (5000×2). Under the dividend reinvestment option, this scheme’s total value drops to the extent of the dividend. So, NAV drops to Rs. 13.
The dividend amount of Rs. 10,000 gets invested. The investor will now get an additional 769.23 units (Rs. 10,000/ Rs. 13). The total number of units jumps to 5,769.23. Now, the total value of this investment will stand at Rs. 74,999.99.
Taking this example for the growth option, NAV would remain unchanged at Rs. 15 per unit, thereby keeping the investment value at Rs. 75,000 (Rs. 15×5,000). As mentioned, the number of units will remain unchanged (5,000) in the case of the growth option.
The following table shows the calculation explaining the growth vs dividend reinvestment option:
|
Particulars |
Dividend Reinvestment Option |
Growth Option |
|
Initial investment |
Rs. 50,000 |
Rs. 50,000 |
|
NAV |
Rs. 10 |
Rs. 10 |
|
Units received |
5,000 |
5,000 |
|
NAV at the end of one year |
Rs. 15 |
Rs. 15 |
|
Declaration of a dividend of Rs. 2 per unit |
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|
Dividend received |
Rs. 10,000 |
NIL |
|
Dividend reinvestment |
Rs. 10,000 |
NIL |
|
NAV post-dividend distribution |
Rs. 13 (15-2) |
Rs. 15 |
|
Units for dividend reinvestment |
769.23 (Rs. 10,000/13) |
NIL |
|
Total units |
5,769.23 |
5,000 |
|
Total value of investments |
Rs. 74,999.99 |
Rs. 75,000 |
In both cases, there might not be much difference in the total value of investments. However, things will change once taxation comes in.
Growth vs Dividend Reinvestment Option: Taxation
According to new IT rules, dividend income from mutual fund schemes is taxable starting on April 1, 2020. There are no relaxations even if the investor reinvests his dividend. So, if an individual falls under the 30% tax bracket, he/she has to pay 30% tax on the dividend declared in a dividend reinvestment option.
On top of that, a TDS of 10% is applicable on a dividend that is more than Rs. 5,000. So, the final investment value is reduced. As per the previous example, a tax of Rs. 4,000 (Rs. 3,000 + Rs.1,000) is levied for the dividend reinvestment option. However, there is no question of tax under the growth option as a dividend is not declared.
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Summing Up
The growth vs dividend reinvestment option helps investors earn more returns. However, the growth option is more beneficial in terms of saving taxes. Investors looking to enjoy the benefits of compounding and lower tax liability can opt for the growth option instead of the dividend reinvestment option.