Dividend Reinvestment vs Growth: A choice between two types of pay out in mutual funds
Investment in mutual fund is quite a simple process. It provides plenty of opportunities to the investors such as diversification, liquidity, flexibility and potential of higher returns at minimum investment cost. Mutual Funds are broadly categorized into two categories, Growth and Dividend. Under the dividend option, it is further subdivided into Dividend pay-out and Dividend reinvestment.
A growth plan mutual fund is basically a fund whose prime investment objective is long term growth of capital. In this plan, profits made by the scheme are invested back into it. This results in the price of NAV rising over time. So, when the scheme gains, the NAV rises and in case of loss, it goes down. The returns in the growth option are in the form of rising value of mutual fund units. Whereas in case of dividend pay-out option, the profits or dividends are distributed to the investor from time to time. The amount and frequency of dividend are never guaranteed.
In the case of Dividend reinvestment option, the dividend is declared but it is not physically out, but instead, it is reinvested back into the scheme to buy out more unit. It is basically a hybrid plan with having features of growth and dividend plan. Let’s understand the basic difference growth and dividend reinvestment:
Growth Vs Dividend Reinvestment
Growth is the stock market term simply referred to as a rise in the value of the share. For example, if an investor buys 100 shares of company A for Rs 50 per share and three months later the market price is increased to Rs 55 per share. The net growth of stock is Rs 5 per share and hence the worth of his portfolio is Rs 5,500. Now similarly, assume an investor has bought 100 shares of some company B for same price i.e. Rs 50 per share and signed up for the company’s dividend reinvestment plan. After few months later, the board of directors announced a dividend of Rs 5 per share. The plan would automatically reinvest the Rs 500 dividend in buying additional company stock. Let’s assume the price per share of the stock has remained unchanged, the investor has 110 shares of company B stocks worth Rs 5,500.
Before choosing between growth plan and dividend reinvestment option, an investor must look upon the following criteria:
- In casean investor is planning for long term financial plan, it’s better to stick with growth plans. After all, in a growth plan, an investor doesn’t have to worry about reinvestment of your intermittent flows at market yield.
- An investment also depends upon the holding period and tax structure. If the holding period is less than 3 years, then you are better off with a dividend reinvestment fund. That’s mainly because, the dividend reinvestment attracts a tax of just 28.33%, while the capital gains tax on a growth plan will be taxed at the peak rate of 33% as short-term gain.
- In case, if the holding period is more than 3 years, then an investor gets the concessional rate of tax 10% without indexation (a technique to adjust tax payments by employing a price index which adjusts for inflation) or 20% with indexation of the growth fund. A growth plan will be more efficient, in case if the holding period in the debt fund is more than 3 years.
The bottom line is that dividend reinvestment plan does not offer any substantial advantage over equity funds.
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*Mutual fund investments are subject to market risks. Please read the scheme information and other related documents carefully before investing.