Growth vs Dividend reinvestment plan

Growth vs Dividend Reinvestment. Which one is better?

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.

growth vs dividend reinvestment
Source: Pexels

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. 

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. 

ParticularDividend reinvestment optionGrowth option
Initial investmentRs 50,000Rs 50,000
NAVRs 10Rs 10
Units received5,0005,000
NAV at the end of one yearRs 15Rs 15
Declaration of the dividend of Rs2 per unit
Dividend receivedRs 10,000NIL
Dividend reinvestmentRs 10,000NIL
NAV post dividend distributionRs 13 (15-2)Rs 15
Units of dividend reinvestment769.23 (Rs 10000/13)NIL
Total units5769.235000
The total value of an investmentRs 74,999.99Rs 75,000
There might be not much of a difference in the total value of investments in both cases. However, things will change once taxation comes in.

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.

Consult an expert advisor to get the right plan for you 

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