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Growth vs dividend reinvestment option: Which is better for you?

17 March 2022

Fund houses provide three different options for investment in mutual funds. The dividend option is for those looking to receive regular income. However, the growth and dividend reinvestment options are suitable for investors seeking to stay invested over a longer period.

The growth option might sound similar to a dividend reinvestment option. But they differ in terms of how they function and how the taxation takes place. The following sections include a detailed guide on growth vs dividend reinvestment options.

About Growth Option

In this option, investors do not receive dividends from stocks that are held in funds. Instead, the dividend is reinvested into these funds, and unitholders will gain from the compounding, that is, earning profits on profit.

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.

About Dividend Reinvestment Option

In the case of dividend reinvestment, dividends from stocks are utilized to buy more units of a fund. 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. However, the NAV reduces under this investment option as it is adjusted with its dividend.

Here’s an example to help investors have a clear understanding.

Let’s say an individual invested Rs. 50,000 in a scheme with a 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:

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
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

There might not be much difference in the total value of investments in both cases. 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 from 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 that is 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 reduces. 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.

Final Word

The growth vs dividend reinvestment option helps investors to earn more returns through reinvestment. 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.

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