Mutual funds are one of the most popular tools of investment. While investing in mutual funds, investors generally have 3 options to choose from Growth, Dividend and Dividend Reinvestment.
While in the growth option, there is no payout, all the profits are reinvested in the fund, in the dividend payout, the profits are paid out to investors on a regular basis be it monthly or quarterly, or annually.
In the third option, the dividends that are paid out by the mutual funds, instead of being directly transferred in your bank account, are used to buy extra units of the fund.
In the dividend plan as well as the dividend reinvestment plan, the NAV (net asset value) of the fund decreases depending on the dividend payout. However, in the latter, even though the NAV decreases, the units increase as the dividend is used to buy more units.
Let's understand with an example.
Suppose you buy 1000 units of a fund with a NAV of ₹10, making your total investment value to be ₹10,000.
In the case of the growth plan, suppose the NAV increases to ₹14 after a year, the total investment value will increase to ₹14,000.
However, in the case of a dividend plan, suppose the NAV rises to ₹14 after a year and ₹2 is declared as a dividend, then after the dividend, the NAV will reduce to ₹2. You will get ₹2,000 ( ₹2*1000 units) as a payout in your account and thus your total investment value will decrease to ₹12,000 (14,000 - 2,000 (dividend)).
Finally in the case of dividend reinvestment in the same scenario, The ₹2,000 which you would have gotten as a dividend will be used to buy more units. With the current NAV at ₹12 (after ₹2 dividend), you buy an extra 166.66 units (2000 dividend/12 NAV). This increases your units to 1,166.66 from 1,000 in the earlier cases. Even though the NAV is less than in the growth plan, but since the unit is more, the total investment value comes to ₹14,000 (1,166.66 units * 12 NAV) after a year.
As seen from the above example, while the units remain the same in the growth and dividend plan, the units increase in a dividend reinvestment plan. NAV, on the other hand, decreases in the latter 2 as compared to the growth plan.
It is very important for investors to decide which plan they want to opt for depending on their financial requirements and investment targets.