All mutual funds offer 2 different options to investors at the time of investing - Growth and Dividend. The main difference between these two is that in the growth option, all profits are reinvested while in the dividend option, the profits earned are paid as dividends at regular intervals.
So let's understand the two options a little better:
Growth versus dividend
1) In the Dividend option, profits are paid out to investors on a regular basis be it monthly or quarterly or annually while in growth one, all the profits are reinvested in the fund.
2) Since profits are invested in the growth option, there may be higher returns in this option over a long period of time in comparison to the dividend option.
3) The net asset value (NAV) in the growth option will always be more than in the dividend option. As the profits are not withdrawn but rather reinvested in the growth option, the fund is likely to grow in value over time more than in the dividend option.
4) The total returns of the growth option are also usually higher than the dividend option due to compounding effects over a long period of time.
5) Dividends are taxed with a mandatory 10 percent TDS in the hands of an investor while in growth option if you withdraw before a year, the returns will be taxed at 15 percent which is the short term capital gains tax but if you withdraw after one-year long term capital gains tax of 10 percent will be applied for returns of over ₹1 lakh.
So where should you invest?
If you do not need cash flow at regular intervals, a growth option is the way to go.
If you are investing for a period of less than 1 year, the dividend plan is more profitable, since the dividends are taxed at 10 percent and in the case of a growth plan your returns would be taxed 15 percent. However, if you are investing for a longer than 1-year growth plan is better since the LTCG is taxed at 10 percent only for returns above ₹1 lakh. This makes the growth plan more suitable for investors with a long-term timeline.
Also, a growth plan is better suited for long-term wealth creation since you have higher NAVs due to reinvestment of profits. So for the same duration of time, say 5 years, the return in a growth plan will be higher than in the dividend plan since, in the latter one, profits have been already withdrawn regularly. One must also note that the investor does not have any say in the dividend distribution plan.
Can you switch between the two options?
It is possible to switch between the two options, from growth to dividends and vice-versa. However, this can be only done by selling the existing units of your MF and buying new ones with the new option. One must note that the sale of MFs might be taxed with a capital gains tax depending on how long you have held the MF.
Even though the underlying portfolio is the same for both options, the choice between growth and dividend must depend on your needs. From a taxation viewpoint, growth is definitely a better option if invested for over a year.