Mutual funds are becoming a popular investment avenue if an April 2021 report by Livemint, a financial daily, is anything to go by. However, deciding which mutual funds to invest in could be a tough job for many. You might get confused when choosing between a growth fund and a dividend fund. The following points will help clear your dilemma about growth vs dividend funds.
Growth mutual fund
In growth mutual funds, the profits generated by appreciation in the price of the underlying assets are reinvested into the fund, reflecting growing profits in the Net Asset Value (NAV). Net Asset Value of your scheme increases with an increase in profits in the scheme and a loss decreases the NAV. In a growth fund, you can claim your returns only after you book profits.
Dividend mutual fund
Profits are rarely reinvested into the scheme in a dividend mutual fund in India. Instead, the profits are distributed among investors as dividends.
Difference between growth and dividend funds
The key point of difference in growth and dividend funds is the distribution of profits to investors. Returns are almost the same in both plans. Returns in a growth plan get reinvested and your returns get compounded. And in a dividend fund, gains are converted into more fund units, which means an increase in the number of shares held by an investor. The following points will bring further clarity between growth and dividend funds.
- Investment goals
To know which fund is suitable for you depends on your investment objectives. If you expect regular income in the form of dividends from your mutual fund portfolio, you should go for a dividend fund. If you wish to accumulate wealth over a prolonged period, a growth fund would be the way to go.
- Returns on invested capital
Growth funds allocate their capital to higher revenue-generating companies. Here you gain the benefit of compounding, which would otherwise be lost on getting regular dividends. Also, in case the fund faces any major loss, you risk losing all your money. In dividend funds, though you can get a regular income through dividends, the rate of dividends is never fixed. So, a greater amount of appreciation of your capital can be experienced in growth funds. As you get a sense of the fund cycle, the growth fund NAV usually increases with an increase in the assets. Although in the case of dividend funds, the NAV generally decreases with each ongoing dividend payout.
- Tax benefits
Taxation must be known before you choose between growth and dividend funds. Growth funds when held for over a year become tax-free. When held for less than a year, tax will be applicable on such short-term capital gains. For dividend funds, dividends given to the mutual fund investors were tax-free as companies used to pay Dividend Distribution Tax (DDT). Post the Union Budget 2020, dividends are added to your taxable income and taxed according to your income tax slab rate.
So, as these factors indicate, different investment goals can result in different outcomes depending on an investor’s personal financial goals and investment horizon. These points will help you make a wise decision when choosing between a growth fund and a dividend fund.