Mutual funds are an optimal investment choice for investors who are looking to diversify their portfolio within their idiosyncratic risk-return parameters. In addition to providing options for wealth protection and growth, they also can potentially help investors achieve their financial goals. While mutual fund investors can choose from a variety of investment classes and themes, another choice they need to make is whether to opt for growth or dividend.
All mutual fund schemes have two options: growth and dividend option. Their Net Asset Values (NAVs) are different and in most cases, NAVs of dividend options are much lower than the growth option. However, this in no way indicates that these are two different schemes or one can potentially generate better returns than the other. The scheme is the same, its objective, fund manager, performance and portfolio are all the same. The only difference is in the nature of the distribution of profits.
Under the growth option, any profits that are made by the scheme are reinvested back into it. This immediately reflects in the NAV of the scheme. If the scheme has made profits, then the NAV of the scheme will increase and if it has made losses then the NAV of the scheme will decrease. From an investor’s perspective, profit or loss from the scheme is realised only at the time of redemption.
Under the dividend option, any profits made by the scheme are not reinvested back into the scheme but are instead redistributed to the investors in the form of dividends. However, it is important to note that dividend payment is neither fixed nor guaranteed. Dividends are declared only when the scheme makes a profit and are usually at the discretion of the fund manager. Under this option, the NAV of the scheme falls to make an adjustment for the dividend payment.
While the main difference between a growth and a dividend scheme is in the way profits are distributed, differential taxation on returns and dividends can have a strong impact on the investment choice.
Growth option works well for equity mutual funds. This is because the growth option ensures that profits are reinvested into the scheme thereby allowing the power of compounding to work for the investor. It is best suited for an investor who is looking to build a long-term corpus to meet his financial goals. The dividend option works best for investors who are looking for regular cash flows and would prefer to reap the benefits of their investments on a periodic basis. Having said that, the dividend option does not guarantee any fixed pay-outs.