In the previous article, the discussion was about debt funds vs hybrid funds. This article will discuss the growth vs dividend reinvestment plan.
A mutual fund is a financial trust that collects funds from investors and invests them into different instruments like stocks, bonds, and other money market instruments.
Fund managers manage mutual funds. They make investment decisions on behalf of the people who have trusted them with their money.
There are different types of mutual funds, such as equity mutual funds, debt mutual funds, and hybrid mutual funds, depending on the investment proportion in debt and equity.
These different types of mutual funds vary in their risk and return potential. Mutual funds are one of the most popular investment options today.
Growth vs Dividend Reinvestment
When it comes to choosing mutual funds, an investor has many options. The choice between a fund with a growth option and a dividend reinvestment option is one of the more perplexing ones.
Each form of the fund has its pros and cons; which is a better fit for you as an investor will entirely depend on your specific needs and circumstances.
If investors are not interested in taking dividends, they can pick between a growth option or a dividend reinvestment option with mutual funds.
With the growth option, the investor allows the fund operator to invest dividend payouts in more securities, increasing their money.
On the other hand, dividend reinvestment allows fund managers to use dividend payments to buy more shares in the fund on the investors’ behalf.
1. The Growth option
The investors don’t earn dividends from stocks held in funds in the growth option. Instead, reinvestments are made from the dividends into these funds – the unitholders benefit from compounding – earning a profit on profit.
Mutual funds’ net asset value (NAV) rises while the number of units remains static. As a result, unitholders who choose this option will be able to create higher returns with the same number of units.
The growth option is not a very smart choice for investors who want to obtain a regular cash distribution from their assets.
It is, however, a strategy to maximize the funds’ NAV and earn a more significant capital gain on the same number of shares purchased, when selling the mutual funds.
An investor does not receive additional shares in this situation, but the value of the fund shares increases.
2. Dividend Reinvestment Option
The option of dividend reinvestment is considerably different. Dividends that would normally be distributed to fund investors are used to buy more shares in the fund.
When the dividend payments are made on the fund’s equities, the investor does not receive cash. Instead, the funds’ administrators utilize the money to automatically purchase more fund units on behalf of the investors and send them to individual investors’ accounts.
This strategy gradually increases the number of shares owned, resulting in a faster increase in account value than if the reinvestments of dividends weren’t made.
Many investment firms provide this service for free to their shareholders. When investors sell their units in a mutual fund, they make a profit.
| Particular | 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 the 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 of dividend reinvestment | 769.23 (Rs 10000/13) | NIL |
| Total units | 5769.23 | 5000 |
| The total value of an investment | Rs 74,999.99 | Rs 75,000 |
Tax rules for the two options
Dividend income from mutual fund schemes is taxable. Starting from April 1, 2020, under the new Income Tax laws, dividend income should be mentioned while filing your ITR. Even if the investor reinvests his dividends, there are no exemptions.
As a result, if an investor is in the 30% tax bracket, he or she must pay 30% tax on all dividends issued in a dividend reinvestment option. A TDS of 10% is also applicable on dividends of more than Rs 5000. The final investment value decreases.
On the other hand, the growth option has no tax implications because no dividend is given out.
FAQs
What is the growth option?
The investors don’t earn dividends from stocks held in funds in the growth option. Instead, reinvestments are made from the dividends into these funds – the unit-holders benefit from compounding – earning a profit on profit.
What is the dividend reinvestment option?
The option of dividend reinvestment is considerably different. Dividends that would normally be distributed to fund investors are used to buy more shares in the fund.
What are the tax implications for reinvestment?
Dividend income from mutual fund schemes is taxable. Starting from April 1, 2020, under the new Income Tax laws, dividend income should be mentioned while filing your ITR. Even if the investor reinvests his dividends, there are no exemptions. On the other hand, the growth option has no tax implications because no dividend is given out.
