Most mutual fund plans have two variants: growth and dividend. As opposed to the growth plan, dividend plans are those in which mutual fund investors get regular dividends at the discretion of the asset management company. Dividend reinvestment plan is a sub-variant of the dividend plan. 

What is a dividend reinvestment plan?

Dividend reinvestment plan is a variant of mutual funds wherein the dividend declared by the mutual fund is reinvested in the mutual fund. In a dividend payout plan, after the dividend is declared out of the fund’s profits, the NAV of the fund reduces by a similar amount. In a dividend reinvestment plan, the dividend paid out is reinvested at the post dividend NAV of the fund.

Not all mutual fund schemes will have a dividend payout and dividend reinvestment option. Some schemes may have a dividend payout option but may not have the reinvestment option. This is completely at the discretion of the mutual fund company so check the scheme information document (SID) carefully before investing.

Growth-Dividend Plan

Growth and dividend plans are the other two variants of a mutual fund scheme that are available along with dividend reinvestment plans.

In the growth plan, if the mutual fund scheme makes any profits, it is not paid out to the investors and is put back into the scheme. This helps the value of your investment compound in the longer term.

In a dividend payout plan, the mutual fund pays dividends to investors out of the profits it earns. 

Therefore, while picking a mutual fund, an investor can choose to go ahead with the growth plan which accelerates the power of compounding for the returns. Otherwise, an investor can choose to get regular income from the scheme or choose to reinvest the same.

How do dividend reinvestment plans work?

As mentioned above, dividend reinvestment plans invest the dividend paid out back into the scheme. Let’s understand how this happens step-wise.

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Stage 1: Let’s assume ‘A’ invested Rs 30,000 in a mutual fund where the NAV was Rs 10 per unit. The number of units allotted to A will be 3000 units.

Stage 2: The mutual fund announces a dividend of Rs 1.5 per unit for the financial year. NAV at the end of the year is Rs 15. A’s total investment value rises to Rs 45,000 (15 * 3000 units) .

Stage 3: In a dividend and dividend reinvestment plan NAV reduces by Rs1.5 to Rs 13.5 per unit.

Dividend= Rs 1.5×3,000= Rs 4,500

Stage 4: In the dividend payout plan, the new investment value will be 13.5 x 3000= Rs 40,500. 

In DRIP, since Rs 4,500 has to be invested back into the plan, we need to find out how many units will come for that amount because what gets invested back is a fresh batch of units. When investors invest a certain amount in mutual funds, the number of units for that amount gets credited to their accounts. So since Rs 4,500 has to be put back into the fund, we need to find out the worth in terms of units. 

The new NAV is Rs 13.5. So the number of units for the dividend reinvestment will be 333.33 units (4,500 / 13.5).

Stage 5: New number of units for A= 3000 + 333.33= 3333.33

Stage 6: Total value of investment will be no. of units x post-dividend NAV: 3333.33 x Rs 13.5= Rs 44,999.9.

Tabular illustration of the three mutual fund plans:

Growth Plan Dividend Plan Dividend Reinvestment Plan
As on January 1, 2019
NAV (in Rs.) 10 10 10
Units purchased 3000 3000 3000
Total investment(in Rs.) 30,000 30,000 30,000
As on December 31, 2019
NAV (in Rs.) 15 15 15
Units purchased 3000 3000 3000
Total investment(in Rs.) 45,000 45,000 45,000
Dividend declared on the date Not Applicable Rs 1.5 per unit Rs 1.5 per unit
Dividend paid to unitholders Not applicable Rs 4,500 Not applicable
Dividend reinvestment amount N.A. N.A. Rs, 4,500
Post dividend NAV (in Rs) N.A. remains the same 13.5 13.5
Units issued for dividend reinvestment N.A. N.A. 333.33
No. of units post DRIP N.A. N.A. 3333.33
Value of investment post dividend Remains Rs 45,000 Rs 40,500 Rs 44,999.9

Tax on Dividends: 

Dividend distribution tax (DDT) was taxable at the hands of the mutual fund companies until union budget 2020. With this budget, DDT has at the hands of the dividend payer which is the mutual fund company. It is now taxable at the hands of the investors at the applicable income tax slab.

To sum up

There are a couple of factors to be kept in mind before choosing between growth and dividend plans. The first thing that needs to be considered is if some sort of regular income is expected from the mutual fund investment. It is a matter of choice and it depends if the investor is looking for any sort of regular income/dividends from the mutual fund investment.  It is not necessary that high dividend-paying debt mutual funds are the best performing mutual funds. There are a host of other factors that need to be considered before investing.

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