There’s always a huge debate going around with respect to the plan an investor should choose while investing.

Each mutual fund typically offers three plans viz. growth, dividend and dividend re-investment.

As an investor what would you choose?

The answer to this question differs from individual to individual and their profile. In this blog, we seek to detail what an investor should ideally do.

Growth option

Funds with growth option mean that the profit generated from the investment in underlying securities remain invested in the fund. The results are the following:

1.Increased Net Asset Value (NAV) of the fund
2.Fixed number of shares

Thus, it means by maturity, in case of long-term investment, you would make a lot more on the same number of shares than you would have before.

Thus, the share in the valuation of funds increases over time.

Dividend reinvestment option

Dividend reinvestment plan is where an option is provided to investors to reinvest the dividends earned them.

Following are the features of the dividend reinvestment option:

1.Comparatively low NAV (adjusted for announced dividend)
2.A higher number of shares

What is the difference?

At a glance, both plans look very similar, especially in terms of profit.

However, if you examine closely, you would see that while profit is directly reinvested in growth option funds, it is re-invested as a dividend in dividend reinvested funds.

This reinvestment of dividend attracts a dividend distribution tax i.e. DDT of 28.84% that has to be paid on the dividends declared.

Thus, the dividend distribution tax is one of the factors that make it noteworthy to understand which option is better in terms of tax saving for you.

Let’s see which plan is suitable under what circumstance

When is growth plan suitable?

Following are situations in which growth plan is more suitable for an investor:

1.Long-term investment in equities

If you are looking for long-term investment capital appreciation, you should ideally stick to the growth plan.

Why so?

Because, under this circumstance, the compounding benefit is much higher than what is available in dividend reinvestment. Opting for a dividend reinvestment plan brings in DDT, which would mean lower capital appreciation.

2.Lower tax slab

If you fall in the lower tax brackets of 10% or 20%, then paying 28.84% as tax for dividend distribution is obviously not a wise choice.

3. Short-term investment in debt funds

If you are planning to invest in debt funds (funds investing in fixed income instruments), you will be taxed for the income generated from this investment.

Taxation is as per the slab. Thus, if you fall in the lower tax bracket, then investment in growth plan is better, as it lowers your taxation as per the slab.

When is dividend reinvestment plan suitable?

Following are the situations where dividend re-investment can be meaningful:

1.Short-term investment in liquid funds

If you are investing in liquid funds for a very short tenure, then you should ideally opt for dividend reinvestment plan. Typically, liquid funds pay dividends either on a daily or weekly basis.

If that is the case with you, then dividend reinvestment is a better choice.

2.Higher tax slab

If you are in the 30% tax bracket, then opting for dividend reinvestment is always better option.

3. If you have a high tax slab and want to invest in debt funds

If you invest in debt funds for a short-term, it attracts tax based on your slab.

If you fall in the 30% tax slab category, opting for a reinvestment plan is better, as you pay only 28.84% tax and not 30%.

Illustration

Let us now detail the intricacies of various plans in a fund. The table illustrates the working of investment under different plans:

Growth plan

Growth Plan
Units bought (April 1, 2018) 10,000
NAV 10
Total value of investment (Rs) 1,00,000
NAV as on 30-6-18 12
Value of investment 1,20,000
Dividend NA
Dividend payment NA
Dividend re-invested NA
NAV post dividend 15
Post Dividend Value 1,50,000

NA – Not applicable

Dividend re-investment plan

Dividend Reinvestment Plan
Units bought (Jan 1, 2018) 10,000
NAV 10
Total value of investment (Rs) 1,00,000
Dividend (April 1, 2018) 2
NAV (April 1, 2018) 13
Dividend Paid (April 1, 2018) Zero
Dividend Reinvested (April 1, 2018) 20000 (Rs 2 x 10000)
Additional Units (April 1, 2018) 1538.46 (Rs 20000/13)
Total Units (April 1, 2018) 11538.46
Dividend (July 1, 2018) 1.5
NAV (July 1, 2018) 15
Dividend Paid (July 1, 2018) Zero
Dividend Reinvested (July 1, 2018) 17307.69 (Rs 1.5 x 11538.46)
Additional Units (July 1, 2018) 1153.84
Total Units (July 1, 2018) 12692.3
Total Value (July 1, 2018) 190384.5

Source: Groww

Fund houses share profit realized periodically by way of dividend.

Under the dividend reinvestment plan, these dividends are only declared but are not passed on to investors.

The dividend obtained is used to purchase additional units. When a dividend is declared, the net asset value (NAV) decreases by an amount equal to the dividend rate. This lower NAV is known as Ex-dividend NAV.

Ex-dividend NAV + Div. Rate = Cum-Dividend NAV

Do these options help investors?

After discussing the different plans and how they work, let us re-iterate a simple question. Does this option actually help investors?

To put in simple words, a dividend reinvestment plan doesn’t make sense if you are in the lower-income bracket, or if you have a long-term investment plan.

If you are a short-term investor with a sizeable investment and fall under a high tax bracket, you must opt for the dividend reinvestment plan. Should you have any further queries, feel free to connect with us and we shall be glad to assist you.

You may also email us your query to support@groww.in.

Happy Investing!

Disclaimer: The views expressed in this post are that of the author and not those of Groww