When investing in mutual funds, investors have the option to reinvest dividends or choose the growth option. While both options can lead to returns, the growth option often provides tax advantages. By reinvesting dividends, you reinvest your earnings back into the fund, allowing for compounding growth and potentially reducing your overall tax liability.
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 dividend 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.
Example
Let's illustrate the difference between growth and dividend reinvestment options with an example.
Imagine an investor invests Rs. 50,000 in a mutual fund scheme with a Net Asset Value (NAV) of Rs. 10 per unit. This would give them 5,000 units.
Dividend reinvestment:
- If the NAV increases to Rs. 15 per unit after a year, and a dividend of Rs. 2 per unit is declared, the total dividend payout would be Rs. 10,000 (5,000 units * Rs. 2/unit).
- Under the dividend reinvestment option, this Rs. 10,000 dividend is automatically reinvested in the fund.
- The NAV would adjust downwards to reflect the dividend payout.
- The investor would receive additional units with the reinvested dividend amount, increasing their overall unit holdings.
Growth option:
- In the growth option, the dividends are not reinvested.
- The NAV would remain at Rs. 15 per unit, and the investor's total investment value would increase to Rs. 75,000 (5,000 units * Rs. 15/unit).
- The number of units held by the investor remains unchanged.
This example demonstrates how the growth option can potentially lead to higher long-term returns through compounding, as the reinvested dividends contribute to the overall growth of the investment.
Particulars |
Dividend Reinvestment Option |
Initial Investment |
Rs. 50,000 |
NAV |
Rs. 10 |
Units received |
5,000 |
NAV at the end of one year |
Rs. 15 |
Declaration of a dividend of Rs. 2 per unit |
Rs. 10,000 |
Dividend received |
Rs. 10,000 |
Dividend reinvestment |
Rs. 10,000 |
NAV post-dividend distribution |
Rs. 13 (15-2) |
Units for dividend reinvestment |
769.23 (Rs. 10,000/13) |
Total units |
5,769.23 |
Total value of investments |
Rs. 74,999.99 |
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.
Growth vs dividend reinvestment option: Tax impact
Dividend income from mutual funds is considered taxable income in the year it is received, even if reinvested back into the fund. Capital gains from mutual funds are taxed differently based on the holding period. Short-term capital gains (holding period less than one year) are taxed at a higher rate than long-term capital gains (holding period exceeding two years).
Are there investments where i can get growth and dividends?
You can achieve both growth and income generation through various investment options:
- Balanced or Hybrid Funds: These funds invest in a mix of stocks and bonds, aiming to provide both capital appreciation and income from dividends and interest.
- Dividend Growth Stocks: These are stocks from companies with a history of consistently increasing their dividend payouts over time.
- Target-Date Funds: These funds are a popular choice among investors. They automatically adjust their asset allocation based on your desired retirement date, becoming more conservative as you get closer to retirement. This strategy provides both growth potential early on and increased stability as you approach your retirement goal.
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.
