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The mutual fund market is vast and offers a wide range of products and schemes to investors. From the size and type of companies to the tenure of the fund, investors have a plethora of options to choose from.
Another choice investors must make before choosing their funds is about the utilisation of returns. This is where the difference between growth and dividend funds arises. Today’s article discusses the meaning of the two funds and the differences between them.
What is a growth fund?
A growth fund, as the term suggests, is a mutual fund that targets growth.
Every mutual fund offers returns to its investors. But, the method of providing returns differentiates the growth fund from others.
Under the growth fund, the dividends earned on investments are not distributed to investors. Instead, they are invested back into the mutual fund. The primary benefit of a growth fund in the mutual fund market is the effect of compounding. Since dividends are put back into the scheme, the principal increases and helps investors earn returns on their dividends.
Growth funds are taxable during redemption. Based on the time of redemption, the returns are liable for short-term capital gain or long-term capital gain taxes.
What is a dividend fund?
Dividend funds, on the other hand, work conversely to growth funds. Investors under the dividend plan receive periodic income in the form of dividends.
The dividends that companies provide are distributed to investors at periodic intervals – annually, monthly, weekly or daily, as agreed. It is essential here to note that the distribution of dividends impacts the fund’s NAV (Net Asset Value). The fund’s NAV goes down according to the dividend issued. The dividends earned under this plan are taxable based on the investor’s existing tax slab.
Another unique option under the dividend fund is the dividend reinvestment option. It is where the dividends are reinvested to buy more units of the fund. While it may seem similar to the growth option, the two differ significantly.
The growth option does not allow declaring dividends, whereas the dividend reinvestment option allows declaring dividends. Hence, the NAV falls under the dividend reinvestment option, but the final value of the fund increases upon purchasing more units.
IDCW vs growth
IDCW stands for Income Distribution Cum Capital Withdrawal. It is a type of dividend fund where investors are given regular payouts.
The Securities and Exchange Board of India (SEBI) introduced IDCW in 2021. Under the IDCW plan, an investor receives dividends, whether or not the companies invested in issue dividends. A portion of the capital is issued as dividends to offer stability to investors desiring income. Such payouts are called IDCW interim. Unlike growth funds, IDCW does not invest dividends back into the scheme. The IDCW plan, like regular dividend funds, affects the fund’s NAV, too.
Dividend vs growth fund
Let’s take an example to understand clearly the difference between these funds:
| Particulars | Dividend plan | Growth plan | Dividend reinvestment plan |
| Units | 5,000 | 5,000 | 5,000 |
| NAV | ₹10 | ₹10 | ₹10 |
| Investment value | ₹50,000 | ₹50,000 | ₹50,000 |
| NAV after a year | ₹15 | ₹15 | ₹15 |
| Investment value | ₹75,000 | ₹75,000 | ₹75,000 |
| Dividend per unit | ₹4 | 0 | ₹4 |
| Dividend value | ₹20,000 | 0 | ₹20,000 |
| New NAV | ₹11 | ₹15 | ₹11 |
| Dividend reinvested | 0 | 0 | ₹20,000 |
| New units | 0 | 0 | 1,818 (₹20000/11) |
| Final investment value | ₹55,000 | ₹75,000 | ₹74,998 |
Summarising the differences between growth and dividend funds:
| Growth fund | Dividend fund |
| Does not pay dividends | Pays out dividends regularly |
| NAV grows in the long-term | NAV reduces due to dividend payouts |
| The end return is higher than dividend funds | The final return on the investment is lower since compounding does not take place |
| Taxes are eligible on short-term and long-term capital gains during redemption | Dividends are taxable as per the investor’s income tax rate |
Which fund should you choose?
The decision about which fund to choose depends entirely on the investor’s financial goals. For investors looking at wealth generation in the long term, growth funds work better. For those looking at stable income regularly, dividend funds work better.
Tax is also an essential component to consider while making a choice. Since growth funds are taxed for capital gains only during redemption, they are considered more tax-efficient.
Bottomline
A mutual fund is an investment vehicle ideal for those looking at moderate risk and stable returns. However, with schemes like the growth fund and the dividend reinvestment plan, it is possible to maximise your wealth while keeping a check on the risk exposure.
But, if you are someone who wants to develop the habit of investing while earning a passive income, you have the dividend fund. There is a plan for every investor in the financial market. So assess your goals, and choose your options wisely!
FAQs
While growth and dividend reinvestment both work on the concept of putting dividends back into the plan, the growth fund works slightly better because of the tax liability only during redemption. Dividends declared under the reinvestment plan are still taxable even if they are reinvested back into the scheme.
Dividend mutual funds are good for those investors seeking low volatility and stable income. It is not ideal for investors looking to increase their wealth aggressively.
ICICI Prudential Dividend Yield Equity Fund, Templeton India Equity Income Fund, Aditya Birla Sun Life Dividend Yield Fund, Sundaram Dividend Yield Fund, UTI Dividend Yield Fund, etc.
Mutual funds go down after paying dividends because dividends are withdrawn from the Net Asset Value (NAV) of the fund, reducing the amount available with the fund. Dividends are not additional income but a portion of the investor’s amount itself.
JM Flexicap Fund, Bank of India Flexicap Fund, Nippon India Flexicap Fund, Motilal Oswal Midcap Fund, SBI Long-Term Equity Fund, Sundaram Small-Cap Fund, etc., are some popular growth options in mutual funds.
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