Mutual Funds offer a variety of options for investors looking to make a buck off the equity market but not yet ready to be befuddled by its complexities.
Investing directly into stock is risky since your returns are tied straight to the performance of a small number of companies selected by you. But in Mutual Funds, your risk is divided into several stocks, bonds and securities, therefore minimising risk and optimising returns. It is only logical that your investment in a single company would cause far more turbulence in your portfolio than an investment spread across a large number of companies from various sectors and market caps.
Mutual Funds differ from each other in proportion of the percentage of money invested in companies, assets, sectors, and other criteria. This diversity allows Mutual Fund companies to cater to a wide variety of investment needs.
One such customised feature is the dividend option versus the growth option available for Mutual Fund investors. In this article, we will discuss both the options.
What’s The Difference?
Growth and dividend options differ in two basic ways.
1) Return to investors
Mutual Funds with a dividend option, as the name implies, provide dividends at regular intervals to investors. Investors in Mutual Funds with a dividend option earn when they receive dividend or redeem their fund units. Growth option, on the other hand, doesn’t provide regular income through dividend. Investors earn profits (or loss, as the case may be) only when they redeem their units.
2) The stated NAV (Net Asset Value) or unit price of the Mutual Fund
A dividend option fund provides regular income to investors, and its NAV is lower than that of a growth fund. It doesn’t mean that dividend funds are valued less.
Let’s understand this with an example.
Suppose an equity Mutual Fund has an NAV of Rs. 30 today. The fund has two variants—growth and dividend. Let’s assume that the companies underlying the equity Mutual Fund have done well in the last year and the stock price of underlying companies has gone up. This has caused the NAV of the equity Mutual Fund to go up.
Now let’s see how the options (dividend and growth) impact NAV.
If the impact on the NAV is Rs. 10, the NAV of the equity Mutual Fund should be Rs. 30 + Rs. 10 = Rs. 40. The growth variant of the Mutual Fund will have an NAV of Rs. 40. Suppose the dividend variant of the Mutual Fund is announced at Rs. 5 per unit. This means every unit holder will get Rs. 5 per unit. Hence the NAV of the dividend option will be Rs. 40 – Rs. 5 = Rs. 35. So, in both the cases, when the investor redeems the investment, they earn Rs. 10 as profit. In the first case, the gain is in the form of capital gains only, while it is combination of dividend income plus capital gain in the second.
Check the NAV of any Mutual Fund with growth and dividend variants and see the difference, which will be nothing but the amount given to investors as dividend.
The Retail Investor’s Choice
As a retail investor, your choice would depend on your investment objective. If you are looking for regular income to support your expenses, Mutual Funds with a dividend option may be preferable. Often, retired people with no source of income, or those who want to complement their income from additional sources, go for this.
If you are looking to build wealth in the long run, you should choose the growth option. Since there are no pay-outs in this option, the effect of compounding is more pronounced in this case. Remember that the dividend that you receive doesn’t earn anything unless you invest it. Investors with a long time horizon, who have a steady source of income, prefer the growth option since their earnings may be sufficient to support their lifestyle and they want to build a corpus for retirement or major life events such as a child’s marriage. Finally, investors are tempted by the lure of regular income from dividends. Avoid this temptation and plan as per your specific requirement.
Remember that the dividend option may not suit everyone. If you are investing for a goal, the growth option is the one you should choose. Also, don’t assume that taking up the growth option will guarantee capital gains. It all depends on the Mutual Fund you choose.