Investing in mutual funds is a popular choice for many individuals, as it offers the potential to create long-term wealth. With various types of mutual funds available, investors have the option to choose from different plans according to their financial needs and goals. Two of the most common types of plans are growth and dividend plans.
Growth and dividend plans both offer different advantages to investors, depending on their individual goals. A growth plan aims to maximize the returns through capital appreciation by investing in equity and debt instruments. On the other hand, a dividend plan focuses on providing regular income to investors by distributing dividends from the profits generated by the fund.
It is important to understand the key differences between growth and dividend plans before making an investment decision. In this article, we aim to present a comprehensive comparison between the two.
The growth option of a mutual fund reinvests the profits made by the fund in its underlying securities to drive future growth and increase fund value. This enables investors to benefit from the power of compounding and helps to create wealth for them in the long run. In such schemes, profits are reinvested automatically and nothing is paid out by way of dividends. This makes them popularly known as auto compounders.
In contrast to a growth plan, the dividend option of a mutual fund distributes the profits made by the fund in the form of dividend income from time to time at the discretion of the fund manager. The dividend payout can help supplement an investor's income but is not guaranteed.
Depending on the choice of the investor, the dividends may either be reinvested in the scheme or paid out in cash. Most mutual funds pay out dividends annually, although debt funds and shorter-term debt funds even offer monthly or quarterly payouts of dividends.
Investments and returns
Investors looking for high returns can opt for growth funds. With such funds, the returns are generated through companies that have a good revenue stream. Although the returns may be higher than those from dividend funds, there is no regular income as the profits are reinvested. Thus, in case of an economic downfall, investors could end up losing their entire investment.
On the other hand, dividend funds provide regular income to investors, but the amount is not fixed. Moreover, the NAV of growth funds will either remain the same or increase due to reinvestment of profits, whereas that of dividend funds decreases when dividend payments are made.
Profit distribution and investment objective
Growth and dividend plans are two of the most common types of mutual fund investments. The primary difference between them is how profits are distributed to investors. Growth plans reinvest returns, allowing investors to benefit from compounding. On the other hand, dividend plans use gains to buy more fund units, increasing the number of shares owned by the investor.
Though the returns on both plans are almost similar, it is important for an investor to consider their investment objectives before choosing either plan. If regular income is the goal, then a dividend plan should be chosen. On the other hand, if long-term wealth accumulation is the priority, then a growth plan is better suited.
Investors who are looking for growth or dividend plans should take into account the tax implications before making a decision. Growth schemes held for more than a year are considered tax free, however, if held for less than a year then a 15% short-term capital gains tax applies.
On the other hand, dividends are now taxable in the hands of investors from April 1, 2020. Investors must now pay tax according to their highest income tax level on dividend income from mutual funds. Thus, the growth plan is more efficient in terms of tax benefits when compared to the dividend option. Hence, investors must factor in all the tax elements before making an investment decision.
To sum up, growth and dividend plans of mutual funds offer different advantages to investors. While growth plans enable investors to benefit from compounding, dividend plans help them to receive regular income streams. Therefore, it is important to understand the differences between these two options before investing in mutual funds.