Growth vs Dividend Reinvestment

The main difference between growth and dividend reinvestment in mutual funds is how returns are used. Growth reinvests profits for long-term capital appreciation, while dividend reinvestment buys more units with dividends. Though both benefit from compounding, dividend reinvestment may be less tax-efficient than the growth option.
Difference Between Growth and Dividend Reinvestment
3 min
17-September-2024

The key distinction between growth and dividend reinvestment options in mutual funds lies in how returns are handled. In the growth option, profits are reinvested back into the fund, helping the investment grow over time, making it ideal for those seeking capital appreciation. In contrast, the dividend reinvestment option automatically reinvests dividends to purchase additional units, which also benefits from compounding but may be less tax-efficient compared to the growth option.

In case the investors are willing to invest in mutual funds, the fund houses generally provide varied options. The dividend option is available for the one who wants to enjoy a regular income. But it is suitable for those investors who want to stay invested for a longer period, with the option of Growth vs Dividend Reinvestment.

This sounds pretty similar to the dividend reinvestment option for growth, but these two aspects defer with respect to their working and how the taxation occurs. For more details on these, please find below some elaborated sections on Growth vs. Dividend Reinvestment Options.

What is the growth option?

The growth option in mutual funds is an investment choice where the profits earned are reinvested in the fund instead of being paid out to the investor as dividends. This option is particularly appealing to those who are not looking for immediate income but are focused on increasing the value of their investment over time.

When an investor selects the growth option, any profits made by the fund through its holdings—such as dividends received from stocks or interest from bonds— are redirected to the fund, thereby increasing the fund’s Net Asset Value (NAV).

This option is ideally suited for long-term investors who have a higher risk tolerance and are looking for substantial returns over an extended period. It is also beneficial for young investors or those who do not need to draw from their investments for regular income, allowing their investments to compound and grow until needed for future financial goals such as retirement or major purchases.

What is a reinvestment option?

The reinvestment option in mutual funds is a method for investors to automatically use their dividends to buy additional units of the fund, rather than receiving these dividends in cash. This option facilitates the compounding of investments, as the dividends that would have been paid out are instead used to increase the investor's holdings in the fund. It is particularly beneficial for those looking to grow their investment over time without needing to manage the reinvestment manually. This strategy is ideal for long-term investors aiming to build wealth through the power of compounding.

Differences between growth vs dividend reinvestment options

So isn't this point to be considered as an important one against the background of new income tax regulations? Dividends received by the investors out of the mutual fund are subject to tax as per the applicable tax slab effective from 1st April 2020.

Suppose, in case, you reinvest back the dividends in a scheme of the mutual fund. In such an event, the income tax rules remain the same: your agency for income tax views them as your income. It means you can even pay the taxes on them when you do not get the payout in your account.

Having said that, if you are in a 30% tax slab, then you will pay around 30% in taxes on the declared profits, which are likely to reduce the mutual fund returns. Also, the dividends paid by the schemes of mutual funds would be at below 10% of TDS when the amount exceeds Rs 5,000.

Meaning, TDS on the payout will be reinvested, so the investment will be on the lesser value.

Notably, the following differences give you an insight into mutual fund growth vs dividend reinvestment:

Aspect

Dividend Reinvestment Option

Growth Option

Definition

Converts dividends or capital gains into additional units

Channels profits directly back into the fund

Income Earned

Automatically reinvests both capital profits and dividends

Does not distribute capital gains or dividends

Purpose

Enhances wealth through the reinvestment of earnings

Focuses on maximising capital growth over time

Preferences

Favoured by investors prioritising total return over other factors

Suited for investors seeking long-term growth


Simply put, the all-in-one investment solution will be unheard of. The preference of a mutual fund growth vs dividend reinvestment is completely on the individual's need. Truth be told, under the long-term investor stands to benefit growth options. However, the preference of those investors remains who would like to have regular payouts, which is the dividend reinvestment option. So, a few of the parameters that you do not end up investing in a fund not suiting your requirements have to be kept in mind. That is how you can better invest in a mutual fund. Now that you are aware of the difference between growth and dividend reinvestment, it will be easy to make a choice that will best meet your financial needs.

Which is better? - Growth vs dividend reinvestment option

When comparing the mutual fund growth vs dividend reinvestment in mutual funds, it is essential to understand your financial goals and tax implications. The Growth option reinvests profits back into the fund, allowing your investment to compound, which is beneficial for long-term wealth accumulation. This option is particularly favourable for investors looking for capital appreciation over an extended period.

On the other hand, the Dividend Reinvestment option provides dividends that are automatically reinvested to purchase more units of the fund. While this option also harnesses the power of compounding, it can be less tax-efficient than the Growth option, as dividends may be subject to taxation, depending on the prevailing tax laws.

Investors must choose based on their financial objectives, investment horizon, and tax situation. The Growth option is generally preferred for its tax efficiency and simplicity in helping build wealth over time, especially for those in higher tax brackets.

Taxation on growth vs dividend reinvestment option

In India, the taxation of mutual fund investments differs significantly between the Growth and Dividend Reinvestment options, affecting investor choice. Understanding the differences of mutual fund growth vs dividend reinvestment is vital for making informed investment decisions.

Taxation on growth option

Under the Growth option, investors are subject only to Capital Gains Tax, which is levied at the time of redemption and switch transactions where there is a capital appreciation. For equity funds, if the holding period is less than one year, Short Term Capital Gains Tax (STCG) of 15% applies. If held for more than a year, Long Term Capital Gains Tax (LTCG) of 10% is charged on gains exceeding Rs. 1 lakh without the benefit of indexation.

Taxation on dividend reinvestment option

Dividends in the Dividend Reinvestment option are subject to Tax Deducted at Source (TDS) at 10% if the total dividend exceeds Rs. 5,000 in a financial year. Additionally, dividends are taxed at the applicable income tax slab rate of the investor, making it potentially less tax-efficient compared to the Growth option.

Here is a comparative table summarising the taxation:

Option

Tax on Dividends

Capital Gains Tax

Growth

Not Applicable

15% STCG / 10% LTCG above Rs. 1 lakh

Dividend Reinvestment

10% TDS + Slab Rate

15% STCG / 10% LTCG above Rs. 1 lakh


Investors should consider their tax bracket, investment horizon, and financial goals when choosing between these options. Generally, the Growth option tends to be more tax-efficient, especially for those in higher tax brackets or those investing for long-term growth.

Key takeaways: Growth vs. Dividend reinvestment

  • Compounding Effect: Reinvesting dividends allows investors to forgo current income in favor of potentially greater future income due to the power of compounding.
  • Growth Fund Focus: Growth funds invest in growth stocks, which are more likely to appreciate over time, offering capital appreciation.
  • Dividend Reinvestment Strategy: By reinvesting dividends, investors purchase more fund units, increasing their stake gradually.
  • Retirement Accounts Consideration: Individual retirement account (IRA) holders often reinvest dividends to avoid early tax penalties on withdrawals.
  • Tax Implications: Both options come with distinct tax consequences, so it's essential to review the tax impact when choosing between growth and dividend reinvestment.

Conclusion

When it comes to optimising investment returns in mutual fund dividend reinvestment vs growth on the Bajaj Finserv Platform, investors face the critical decision between selecting between mutual fund dividend reinvestment vs growth and learning how to choose from mutual funds. Each choice has distinct tax implications and aligns differently with various investment strategies and financial goals. The Bajaj Finserv Mutual Fund Platform, offering access to over 1000+ mutual funds schemes, provides ample opportunities for investors to tailor their investment approach according to their individual needs where they can also compare mutual funds.

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Frequently asked questions

Is it better to take dividends or reinvest?
It is generally advisable to reinvest dividends as it automates the investment process, incurs no fees, and significantly boosts the value of holdings over time. For instance, reinvested dividends in a company like Microsoft could increase the worth of investments by 63% over a decade compared to not reinvesting.
Should I stop reinvesting dividends?
Whether to stop reinvesting dividends depends on your financial goals and portfolio balance. While reinvestment can accelerate portfolio growth through compounding, there are situations where taking the dividends as cash might be better, such as when rebalancing your portfolio or needing income. Generally, continuing to reinvest makes sense if you're aiming for long-term growth and are comfortable with your investment in the underlying stock.
Does reinvesting dividends avoid tax?

Reinvesting dividends does not avoid taxes. Dividends are taxed in the year they are paid, regardless of whether they are reinvested or taken as cash. Thus, when dividends are reinvested, the investor still owes taxes on them as if they had received them in cash.

What is the point of reinvesting dividends?
The main purpose of reinvesting dividends is to benefit from compound growth. By automatically purchasing additional shares with the dividends paid out, investors can increase the quantity of shares they own, enhancing potential gains and compounding their investment over time without additional out-of-pocket expense.
Do dividends reduce income?
Dividends do not reduce income for the recipient; rather, they are considered income themselves and are taxable. For a company, dividends are not an expense but a distribution of earnings to shareholders, so they do not reduce the company's income either.
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Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.