There are two ways how your mutual fund investments provide returns — all at once when you redeem units or during the course of your investment. The former is called growth option and the latter dividend option.
Investments made in the growth option are allowed to compound until you make a redemption request. The returns made on your original investment are ploughed back into the scheme where they continue to grow and produce even more returns and so on. As a result NAV (Net Asset Value), which reflects the value of each unit, keeps growing over time in a growth scheme.
Whatever profits made are paid out to unit holders from time to time in this option. As a result, the NAV of dividend option is always lower than the growth option of the same fund. Further, you can choose between dividend payout and dividend reinvestment. While all profits are paid out to your bank account in the payout option, in the dividend reinvestment option the profits are invested again by proportional allotment of new units to you.
One important point to remember is that choosing a dividend option does not guarantee returns.*
Choosing between growth and dividend
Since compounding helps in wealth creation in the long run, you should allow investments to compound by going for the growth option, unless you need to live off returns. In fact, even when you need regular income from your mutual fund investments, choosing an SWP (Systematic Withdrawal Plan) on a growth option could prove to be more prudent than choosing the dividend option.
Another consideration in this choice is taxation. Returns from the growth option attract capital gains tax, and in case of equity funds there are no capital gains tax for investments held for over a year; thus investing in equity funds, for long term investment growth options is better. Dividend options do not attract tax at the hands of the investor. However the fund house pays DDT (Dividend Distribution Tax), which in the end is deducted from the NAV. So in the choice of growth v/s dividend in debt funds, one should also consider one’s tax slab and DDT rate.
To clarify, the investment portfolio, and therefore the fund’s performance in both options stay the same. The only point that differs is the method of accounting, expenses charged and consequently the NAV of these two options. The choice of growth v/s dividend is made at the start of investing, so make your choice after giving this considerable amount of thought.
* Dividends are subject to availability of distributable surplus and approval of Trustees.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.