GROWTH VS DIVIDEND MUTUAL FUNDS, WHICH MUTUAL FUND PLAN IS BETTER?
When we invest in mutual funds, we usually have the choice of investing either in a dividend plan or growth plan of the same fund. You will also know that the dividend plan normally tends to have a NAV on a lower end when comparing the growth funds. The growth plan just accumulated the money while dividend plans offer a pay out of regular dividends.
In this article, we are going to understand both types of plans in detail.
GROWTH PLAN OF MUTUAL FUNDS
In the growth option, profits made by the fund scheme are re-invested in the fund itself so nothing is paid out by way of any dividends. Therefore, these schemes are referred to as auto compounders as there is automatic reinvestment of fund returns in the same funds. This assists in creating wealth for the investors in the long run. Since profits are reinvested, we also earn returns over the reinvested part and principal too. That is how the compounding works here which is much more effective when it comes to growth.
Important points of Growth Plans:
- The overall returns of growth option are usually better than the dividend option over longer tenure as the compounding effect favours the growth plans while it worlds contrary to the dividend plans.
- There exist no difference in the composition and portfolio of growth and dividend plans. It is only the dividend payout model that changes. The dividend plan NAV is only reduced by the dividend payout and nothing else.
- When we sell a growth plan fund, it generates capital gains which is taxed as it is. Effectively there is no incidence of tax in growth options unless investors sell or redeem the units of the funds.
- These plans follow as a logical corollary that the NAV here will be higher when compared to the dividend plan because the profits are reinvested in the plan here and nothing is paid out to the investors.
DIVIDEND PLAN OF MUTUAL FUNDS
If you opt for these plans, profits made here are paid out to investors either in full or partially, such dividends are declared at regular intervals. The mutual funds can payout dividends in any frequency including weekly, monthly, quarterly, semi-annually, etc. depending on the plan selected by the investor.
This plan itself is further divided into three sub plans. There is a Payout of Income Distribution and Capital Withdrawal option, Reinvestment of Income Distribution and Capital Withdrawal option, & Transfer of Income Distribution and Capital Withdrawal.
Important points of dividend Plans:
- Dividends can’t be assured. This applies to equity funds and even to liquid and debt funds. Neither the payout time nor the quantum can be assured by the fund.
- Dividends can only be paid out from the distributable surplus of the scheme, which is NAV accretion. The dividend can also include the capital portion of the investor.
- Dividends do not attract any tax because dividends are fully taxable in the hands of investors. Nevertheless, effective the budget 2020, there is a compulsory 10% TDS deduction from dividend income for resident individuals if the income is more than Rs 5000 for one financial year.
- Very significant to know that the payouts are adjusted from the NAV of the fund. Hence, the NAV of these plans sees a drop to the extent of the dividend paid.
WHICH PLAN IS BETTER FOR LONG TERM?
If we were to opt, we would have gone for growth plans. Your long term goals work on the principle of compounding which is highly beneficial in long term and wealth creation. That is only possible through auto reinvestment which happens in a growth plan. When you are planning for long term goals like college education or retirement , the power of compounding will be your biggest asset.
But, that only works if returns are constantly reinvested in the mutual fund. If you opt for a dividend plan most of the returns will be cashed out in the form of dividends and hence actual wealth creation will be much lower. A growth option is like an auto compounder and therefore more compatible in long term visions and goals like buying a house, child education, retirement, etc.