Dividend Mutual Funds Or Growth Mutual Funds ??

In my previous post related to mutual funds, I have given details about Mutual funds options like Growth, Dividend and Dividend Re-investment. Just to summarize those details here:

Growth funds keep investing the profits made on investment, so if your investment makes 10 Rs Profit on 100 Rs in certain time, that 10 Rs will be invested in same fund so here your unit NAV value increases and not the count of units.

Dividend Funds share partial profit with investors and invest remaining profit, so if your investment makes 10 Rs Profit on 100 Rs in certain time, that 3-5 Rs will returned to as dividend and remaining will be invested in same fund.

If we see Growth option, expert say it gives compounding return because your profits are getting Re-invested. Note that it is not compounding interest that banks give, it is compounding return which might be uncertain. If we think bit pessimistically, what if there is a crisis in market or mid-term negativity at a time when you are already sitting on ‘supposed to be good’ profit? The profits accrued in that amount of time might get wiped out or get reduced. Assume if you keep making 10% annual return for 3 years on your investment that you did at start of 1st year, as per rule of compounding return, fund will be at 33% return at end of 3^rd year. Now what if market goes down due to some issue and fund gives 15% negative return for 4th year? In this case after 4 years return will be around 13% as profit.

If we take Dividend option of same fund with exactly same scenario viz. what if there is a crisis in market or mid-term negativity at a time when you are already sitting on ‘supposed to be good’ profit? The profits accrued in that amount of time might get wiped out but you must have already got good part of that profit in form of Dividend in previous 3 years. Say on 100 Rs investment, fund gave 10% return in 1^st year and you got 50% of profit as dividend, so on 10 Rs Profit you would get 5 Rs as dividend and 5 Rs will be Re-Invested. If this process is continued for 3 years, after end of 3^rd year, you would have got around 16% as dividend back and 15% profit in portfolio. Now what if market goes down due to some issue and fund gives 15% negative CAGR for 4th year? after 4 years you will still have had 16% profit in pocket as dividends (as there will normally be no dividend in 4^th year because of negative return) and your existing portfolio would have had 1% loss,so over and all 15% as profit.

So to summarize the case above, in exactly same scenario, Growth option will give 13% profit while Dividend option will give 15% profit, most importantly with less risk in long term.

Now things that I have mentioned might sound hypothetical but that’s how market runs. I think it is better to have Growth option when you have no worry about uncertainty of market, can wait for really really long time and have less worry of money you are putting in, but if you have little bit worry about uncertainty, go for Dividend option. With Dividend you will not only get money back on regular intervals, your risk will always be in balance. Remember that if you want great corpus after 15-20 years then always go for Growth option as you won’t be taking out any money from fund until 15-20 years in any case.  

Pessimist way:

If fund is giving consistently negative returns, Dividend and Growth option both will give same negative return.  

Optimist way:

If fund is giving consistently positive returns with very rare negative return in any year, Growth option will give better return than Dividend option.

Balanced way:

If fund is giving fluctuating returns with few years of positive return followed by negative return in any year, Dividend option will give better value than Growth option.

Keep in mind that all afore mentioned scenarios are for Equity Mutual funds as for Equity mutual funds there is no long term capital gain tax, no tax on Dividend received and also no Dividend Distribution tax ( unlike for Shares). Relevance of these options change for Debt Mutual funds as for those funds even dividends gets taxed. 

Dividend Mutual Funds and Growth Mutual Funds

To choose Growth or Dividend option while putting money in Equity mutual funds? Though many of us just like to invest money and don’t think much about what are the options that are there in Mutual funds, some of us do think about it in detail before taking a decision. There is enough material available to understand these options and this post can be just one of those many but in my words.  

I just want to make one thing clear that Dividend and Growth options are exactly same funds with exactly same investments, only difference is how these funds manage the Profit accrued in certain amount of time.  

Growth funds keep investing the Profits made on investment, so if your investment makes 10 Rs Profit on 100 Rs in certain time, that 10 Rs will be invested in same fund so here your unit's NAV value increases and not the count of units.

Returns in Growth Funds:

This option gives compounding return because your profits are getting Re-invested. Note that it is not compounding interest that banks give, it is compounding return which might be uncertain when mutual fund’s performance goes down after some good profitable years. Say if you invest 100 Rs on X-date and Mutual funds gives 10% return every year for 3 years, so as per rule of compounding return, after 3 years your return will be 33% .

Dividend Funds share partial profit with investors and invest remaining profit, so if your investment makes 10 Rs Profit on 100 Rs in certain time, then 3-5 Rs will returned to as dividend and remaining will be invested in same fund hence it will increase unit's NAV value but not as much as in Growth option. 

Returns in Dividend Funds:

This option gives assured (of-course only in case of profitable performance of funds) + compounding return because part of your profit is getting back to you as dividend and part is getting Re-invested. Say if you invest 100 Rs on X-date and mutual funds gives 10% return in 1^st year and then gives back 50% of profit made as dividend, so on 10 Rs Profit you would get 5 Rs as dividend and 5 Rs will be Re-Invested. If this process is continued for 3 years, after end of 3^rd year, you would have got around 16% as dividend back and 15% profit in portfolio which when added becomes 31% that is little bit less from Growth option. 

Apart from this there is one more scheme available related to Dividends called “Dividend Re-Investment”, I personally feel that this scheme is one of the worst options available in funds. Here Mutual fund will show that 10 Rs is dividend and then Invest that 10 Rs in same fund, just like growth fund but here difference comes in case of Debt funds for taxation. In such Equity funds count of your units will increase in portfolio. One more negative with this option is that capital gain is incremental, so if funds buy new units through dividend money, the new units need to be held for next 1 year to avoid capital gain tax and such calculation can be really messy for normal investor.

There is no tax on Long Term Capital gains in Equity mutual funds , no tax on Dividends received and also no Dividend distribution tax on Equity mutual funds ( unlike in stocks where company before giving dividend to shareholders cuts dividend distribution tax and pays to government) . For Debt funds apart from no Long term gain tax, dividend distribution and dividend received tax both are there.


*MutualFundInvestmentsAreSubjectToMarketRiskPleaseReadTheOfferDocumentCarefullyBeforeInvesting