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Growth, Dividend Payout and Dividend Reinvestment Option in Mutual Funds

The last couple of posts dealt with the basics of Mutual Funds. The first one explained what Mutual Funds were and the second one explained the categories in which they fall into.  This article will explain the difference between the three options which are offered to investors investing in a Mutual Fund. It will also help you determine the questions you should ask yourself while deciding which option is better for you.

The three factors that will help you choose which option is best for you are :

  1. Money Requirement: Do you need income at regular intervals during your MF investment period or are you just interested in capital appreciation?
  2. Tax Regime in Place: According to the tax laws applicable, which of the three options make more sense for you?
  3. Nature of the Mutual Fund: Is your Mutual Fund an equity oriented scheme ( > 65 % corpus invested in equities) or a debt oriented one? There are differen t tax laws applicable for both.

We will look into how these three factors will shape your choice. Before we do that, let us review what these three options actually are.

 Growth, Dividend Payout and Dividend Reinvestment Option in Mutual Funds

  1. Growth Option: In the growth option, all the pro fits made by the Mutual Fund are re-utilized by it to increase the corpus and thus the NAV of the fund.  The investor is not paid dividends at all. This option is suitable for investors interested in capital appreciation.
  2. Dividend Payout: In this option, the Mutual Fund will pay back Dividends to unit-holders when it deems fit.  Please note that these dividends are NOT the dividends issued by companies whose shares the mutual fund holds. It is in fact, your own money which is being given back to you by calling it a dividend.  This money is gained by reducing the NAV of the units in the fund. Therefore, as a dividend is paid, the NAV of the fund will reduce compared to a similar fund with a growth option. Beware of funds that advertise their dividend declaration to attract new investors.
  3. Dividend Reinvestment: In this option, the dividends are issued but they are not paid to the investor. Infact, they are utilized to buy more units of the same fund for the investor.

You will find that there are only two NAV’s shown for a fund, Growth and Dividend. The NAV of the Dividend Reinvestment option, as you may have guessed will be the same as the NAV of the Dividend Payout option of  the same fund. And obviously, the NAV of the growth option of a fund will be higher than the NAV of the dividend option of the same fund.

Here is an example to clear things up:

For a MF with 10,000 units and a NAV of 10 Rupees, there are 3 options on offer – Growth, Dividend and Dividend Reinvestment. An investor, holds 100 units of this fund.

Growth: No Dividends declared. The NAV remains same for the moment.The number of units with the investor also remain same.

Dividend Payout:A dividend of 2 Rupee per unit declared. The investor gets 200 Rupees because he holds 100 units. The Corpus of the fund initially was  = 1,00,000 (NAV X No. of Units). Now, it is 1,00,000 – 20,000 = 80,000. The new NAV of the fund is = 80,000/10,000 = 8 Rupees (Corpus/No. of Units).  The number of units with the investor remains the same because no units were purchased on his behalf.

Dividend Reinvestment: A dividend of 2 Rupee per unit declared. But, the investor does not get the money. His dividend and that of other investors is utilized to buy up more units of the fund for them. New NAV of the fund is 8 Rupees as before. As the investor is getting 200 Rupees as Dividend, all this money is used to buy more fund units . He will get 200/8 = 25 new units.

In the first and last cases , note that value of investment ( NAV X Number of units) remain the same.

Move on to this article to find out how to choose the right option.

Tagged as: Dividend Payout, Dividend Reinvestment, Growth, Mutual Funds

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