Growth vs Dividend Mutual Funds: Which one is better?
The Equity Mutual Fund comes in various forms. You can either invest your savings in a Small-Cap Fund, Mid-Cap Fund, Large-Cap, Balanced Fund or Multi-Cap Fund to go for. You can opt also for an ELSS Fund if you are planning your personal Income Tax for the next Assessment Year.
Whatever be the category of an Equity Fund you choose to park your money in, this will either be in the nature of Growth Plan or Dividend Plan. In this post, we are going to discuss growth vs dividend mutual funds and which one is better for investors.
You might think that dividends from equity funds can be used for generating regular income. However, the fact is that regular dividend payouts are only possible if the fund generates profit regularly.
Moreover, for an equity fund to be a sustainable profit generating fund, the stock market is also required to be going upwards. If the market shows correction for a substantial period of time, it won’t take much time for the flow of regular dividend to get stopped.
Again, you might be an investor who thinks choosing dividend plan for booking regular profit without redeeming your units held. This might seem to be good as a strategy on the paper but, for its execution, proper planning is required.
Further, it could also be possible that you have just read the names of these two plans for the first time and completely unaware of the idea behind Growth and Dividend plan. You might not know what they actually mean and end up selecting something randomly just for the sake of investing in an Equity Fund.
Growth vs Dividend Mutual Funds
Now, let us understand how Growth Plan and Dividend Plan work in real life.
In the Growth option, the profits in the form of capital appreciation and dividend, made by your scheme are re-invested into the same fund. This will lead to the rise in the Net Assets value (NAV) of the scheme with time.
When the underlying portfolio of the fund makes profits, the NAV of its units rises. Similarly, you’re your fund runs at a notional loss, supposedly due to the market correction, the NAV of the same fund goes down.
In the case of Dividend Plan, the profits made by your fund are not reinvested back into the fund by the Fund Manager of the Asset Management Company (AMC). You get a share in the said profits in the form of dividends from time to time.
The amount of dividend you get and the frequency of getting the same are not predetermined. Dividends are only declared by the AMC when the scheme realizes profits in real.
In the Dividend option, the dividend is paid to you from the NAV of the units you hold, so paying dividend reduces your overall NAV.
Now you have come to know how Growth Plan and Dividend Plan work. Our recommendation would be to go for the Growth option.
Why Growth Plans?
Let us discuss why you should choose Growth option over Dividend Plan while investing your savings in Equity oriented Mutual Fund.
For example, if your Long-term Capital Gain in a growth plan investment is Rs 50000 for the Financial Year 2018-19, you don’t need to pay a tax on it. But, if the same becomes Rs 150000, then LTCG tax is chargeable on Rs 50000, i.e. the amount in excess of Rs 1lakh.
On the other hand, if you have invested in a dividend plan, the entire dividend you have received is subject to DDT. No exemption limit is applicable to an equity dividend option similar to a growth plan equity scheme. The equity funds with growth plan are more appropriate for long-term wealth generation than dividend based equity funds. The amount of dividend you would receive in the latter option is not going to be a significant one.
You are most likely to spend that money in your day to day expenses and it is hardly going to be reinvested by you in the market.
But, if you have invested in a performing equity fund with growth option, the latter refrains from paying you any return in cash. So, the returns get reinvested in the same fund and get compounded year on year. This leads to the generation of substantial wealth in the long term.
What if you have already invested?
If you have invested in a dividend plan and the duration has crossed a year, you are recommended to switch to the growth option within the Financial Year 2018-19. Here, switching means redeeming units of one fund and investing the proceeds in another scheme.