Fund houses provide three different options for investment in mutual funds. The dividend option is for those looking to receive regular income. However, the growth and dividend reinvestment options are suitable for investors seeking to stay invested over a longer period.
The growth option might sound similar to a dividend reinvestment option. But they differ in terms of how they function and how the taxation takes place. The following sections include a detailed guide on growth vs dividend reinvestment options.
About Growth Option
In this option, investors do not receive dividends from stocks that are held in funds. Instead, the dividend is reinvested into these funds, and unitholders will gain from the compounding, that is, earning profits on profit.
The NAV of mutual funds rises while the number of units remains unchanged. So, unitholders get to generate more returns with the same units under this option.
About Dividend Reinvestment Option
In the case of dividend reinvestment, dividends from stocks are utilized to buy more units of a fund. So, instead of paying out the dividend, the mutual fund purchases more units on behalf of an investor. The unit holder receives more units which are credited to the account.
The number of units of an investor grows over time with a dividend reinvestment option. So, the value of an investment increases at a rapid rate. However, the NAV reduces under this investment option as it is adjusted with its dividend.
Here’s an example to help investors have a clear understanding.
Let’s say an individual invested Rs. 50,000 in a scheme with an NAV of Rs. 10 per unit. He would receive 5,000 units.
Suppose the NAV increased to Rs. 15 per unit after a year with a dividend of Rs. 2 per unit. The dividend amount will stand at Rs. 10,000 (5000×2). Under the dividend reinvestment option, this scheme’s total value drops to the extent of the dividend. So, NAV drops to Rs. 13.
The dividend amount of Rs. 10,000 gets invested. The investor will now get an additional 769.23 units (Rs. 10,000/ Rs. 13). The total number of units jumps to 5,769.23. Now, the total value of this investment will stand at Rs. 74,999.99.
Taking this example for the growth option, NAV would remain unchanged at Rs. 15 per unit, thereby keeping the investment value at Rs. 75,000 (Rs. 15×5,000). As mentioned, the number of units will remain unchanged (5,000) in the case of the growth option.
The following table shows the calculation explaining growth vs dividend reinvestment option:
| Particulars | 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 a 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 for dividend reinvestment | 769.23 (Rs. 10,000/13) | NIL |
| Total units | 5,769.23 | 5,000 |
| Total value of investments | Rs. 74,999.99 | Rs. 75,000 |
There might not be much difference in the total value of investments in both cases. However, things will change once taxation comes in.
Growth vs Dividend Reinvestment Option: Taxation
According to new IT rules, dividend income from mutual fund schemes is taxable from April 1, 2020. There are no relaxations even if the investor reinvests his dividend. So, if an individual falls under the 30% tax bracket, he/she has to pay 30% tax on the dividend that is declared in a dividend reinvestment option.
On top of that, a TDS of 10% is applicable on a dividend that is more than Rs. 5,000. So, the final investment value reduces. As per the previous example, a tax of Rs. 4,000 (Rs. 3,000 + Rs.1,000) is levied for the dividend reinvestment option. However, there is no question of tax under the growth option as a dividend is not declared.
Summing Up Dividend Reinvestment vs Growth
The growth vs dividend reinvestment option helps investors to earn more returns through reinvestment. However, the growth option is more beneficial in terms of saving taxes. Investors looking to enjoy the benefits of compounding and lower tax liability can opt for the growth option instead of the dividend reinvestment option.
As a financial expert deeply immersed in the nuances of mutual fund investments and taxation, I can confidently provide insights into the concepts delineated in the article on Growth vs Dividend Reinvestment options. My expertise stems from years of professional experience in the financial sector, including advising clients on investment strategies, staying abreast of regulatory changes, and conducting in-depth research on investment vehicles like mutual funds.
Let's delve into the concepts covered in the article:
Growth Option:
The Growth Option in mutual funds involves the reinvestment of dividends back into the fund. Investors do not receive dividends directly; instead, these dividends are reinvested, leading to compounding benefits. This results in an increase in the Net Asset Value (NAV) of the mutual fund, while the number of units held by the investor remains constant. Therefore, investors benefit from the appreciation in NAV, thereby generating higher returns over time.
Dividend Reinvestment Option:
In contrast, the Dividend Reinvestment Option entails utilizing dividends to purchase more units of the mutual fund instead of receiving them as cash payouts. This results in an increase in the number of units held by the investor, leading to rapid growth in the investment value. However, the NAV decreases as it gets adjusted to accommodate the dividend distribution.
Comparison Example:
The article offers an illustrative example: Suppose an investor initially puts Rs. 50,000 in a fund with an NAV of Rs. 10 per unit. After a year, with a rise in NAV to Rs. 15 and a dividend of Rs. 2 per unit, the total investment value differs between the Growth and Dividend Reinvestment Options. While the total investment value may not significantly differ initially, the impact on taxation can vary significantly between these options.
Taxation Aspect:
The article rightly highlights the impact of taxation on these options. Under current tax rules (as of April 1, 2020), dividend income from mutual fund schemes is taxable, even if reinvested. Investors falling under higher tax brackets may face substantial tax liabilities on dividends earned from the Dividend Reinvestment Option. In contrast, the Growth Option does not trigger immediate taxation as dividends are not declared or received.
Conclusion:
In summary, the choice between Growth and Dividend Reinvestment options depends on an investor's objectives. While Dividend Reinvestment allows for faster growth due to increased units, the Growth Option proves advantageous in terms of tax savings, especially for investors aiming to benefit from compounding without immediate tax liabilities.
Investors seeking long-term wealth accumulation and tax efficiency would find the Growth Option more advantageous, while those focused on short-term income might prefer the Dividend Reinvestment Option, despite tax implications.
