Q. I want to invest in a specific fund, but I see a huge gap between its growth and dividend NAV. Please advise.
As you must be aware, mutual funds are divided into two categories: growth and dividend.
Under the dividend option, profits are distributed to investors at regular intervals. This dividend is deducted from the scheme's net asset value (NAV). As a result, once the dividend is paid to investors, the scheme's NAV falls.
In growth funds, profits made by the scheme are reinvested in the scheme and not paid out to investors. You end up earning a profit on profit and thus benefit from compounding. Unlike the dividend option, the growth scheme's NAV does not drop after the dividend is paid. Rather the NAV will be higher because the profits reinvested in the growth option increase in value over time. Let us study an example:
At its inception, the NAV of a scheme was 10. The NAV increased to 12 in two years. If the fund house declared a dividend of 2, and the scheme had a dividend option, its NAV would reset to 10. Under the growth option, the NAV would have remained at 12.
Assume you invested ₹1 Lakh and bought 1000 units of a scheme at a NAV of ₹100. A dividend of ₹2 per unit was declared. Let’s see the impact of both the options.
DDT = Dividend distribution tax
The dividend option provides income but doesn’t help much in growing wealth. One may lose out on the compounding of returns. The dividend pay-outs are also not regular. It can take months and the amount may also vary. Also, dividends are taxable in the hands of the investor. This tax can be avoided under the growth option.
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