With so many mutual funds available in the market, selecting a mutual fund for your investments can become quite a task until you know certain differences. One such difference is between growth and dividend options available in mutual funds.
In growth option, you are not paid out any profits made by your underlying investments in mutual funds. The profits here are reinvested. In dividend option, a part of the profits made by the underlying investments is paid out to the investors. Growth and dividend mutual fund of a given fund house perform at par, but what separates these two is what is done with the profits and this ultimately impacts the NAV (net asset value).
Profit reinvestment in case of a growth option increases the NAV resulting in capital appreciation. In the case of dividend option, when the mutual fund house makes some profit, the NAV first rises, and then a part of the profit is paid out to the investors. The NAV then reduces by the amount paid out to the investors per unit. After dividend distribution, the new investments in the mutual fund are accepted at the ex NAV rate.
Reinvestments of profits in case of a growth option has a compounding effect since your initial investment, as well as the returns, start earning more returns. In the case of dividend option, since a part of the profit is paid out to the investors, compounding effect is not at its full potential.
The growth as well as the dividend option of a given mutual fund house perform at par. This basically means that the fund performance remains the same irrespective of the option you choose. What differentiates them is what they do with the profits. In case of growth option, you can realize the gains only on selling the units. In the case of dividend option, there are 2 ways through which you can realize your gains. First is through the dividends that you receive and the second is on selling the units. By selling the units, you will get profits which were not paid to you via the dividend.
People looking for capital gains over the longer period and not looking for periodic income should go for the growth option and people looking for periodic income like retirees etc. should go for dividend option. Also, if someone wants an additional or side income can go for the dividend option.
The taxation of growth, as well as dividend options of a mutual fund, is the same. If your mutual fund is an equity mutual fund, and if you hold on to your investments for less than a year, your gains are taxed at 15%. If you hold on to your investments for more than a year, your gains are not taxed. If your mutual fund is a debt mutual fund and if you hold on to your investment for less than 3 years, the gains are taxed according to your tax slab. If you hold on to your investments for more than 3 years, your gains are taxed at 20% but after indexation. The dividends are tax-free in the hands of the investors. The mutual fund has to pay a dividend distribution tax in case of a debt fund which is around 28% of the actual amount paid to the investors. In the case of equity mutual funds, there is no dividend distribution tax. Also, the dividends are paid out only when the mutual fund makes some profit.
So the factor that ultimately influences your decision when you want to choose between a growth and a dividend option of a mutual fund is your need. If you are looking for periodic income as well as moderate capital appreciation of your investments, you should go for dividend option. And in case you are not looking for periodic income from your investments but looking for capital appreciation alone, you should go for the growth option.