The dividend is not paid to the investor, often it is considered as equivalent to growth option but there is a difference. Let us understand each of the options and see what’s the difference between dividend re-invested option with growth option and which is a better choice for an investor.
Right Stock at Right Price for Right Time
Have you ever invested in a stock on someone's advice to make profit and then has to wait for months, maybe years, to recover capital? Not anymore.
There are 3 choices from a dividend point of view in each of a regular plan or a direct plan. (Direct plans is recommended)
- Growth Option or No Dividend Option.
- The dividend is paid out to the investor.
- The dividend is re-invested in the same fund.
In the third option, as the dividend is not paid to the investor, often it is considered as equivalent to growth option but there is a difference.
So let us understand each of the above options and see what’s the difference between dividend re-invested option with growth option and which is a better choice for an investor.
The invested amount allocates the number of units to the investor based on the NAV value of each unit on the given date of investment.
If the NAV of a fund is ₹10 and if investors invest ₹10,000. He will be allocated 1,000 units.
In the growth option, the number of units remains the same for the investor till the investor redeems them partially or fully.
Funds declare dividends from time to time. Some funds pay dividend quarterly whereas others opt to pay yearly.
The amount of dividend declared by a fund is paid to the investor and the NAV for the fund is reduced by the same price per unit as the dividend.
What it means is if the NAV of the fund is ₹12 and if the fund declares the dividend of ₹1. The Nav of the fund for the following day will become ₹11 assuming there is no change in the net asset for a day. If there is a change in the net asset, the NAV is adjusted accordingly.
The amount of dividend declared by a fund is not paid to the investor but instead, it is used to purchase more units of the same fund.
Let us understand this with an example.
If the NAV of a fund was ₹10 and if investors invested ₹10,000, he was allocated 1,000 units.
The NAV of the fund increased over time to ₹12. The mutual fund declares a dividend of ₹1. Let us assume the NAV of the fund the following day is ₹11.
The dividend of ₹1,000 was to be paid to the investor but as the option selected by the investor was dividend re-investment. The fund automatically purchases extra units of the fund for the investors.
So the number of units purchased by the fund for the investors is 90.90.
Now the total number of units of the investor has increased from 1,000 to 1,090.90 and they are being valued at ₹11.
|Amount Invested||NAV||Units||Final Amount|
+₹1,000 (Paid as Dividend)
The number of units multiplied by the NAV is the final amount.
- In dividend payout option the number of units remains the same as the growth option.
- In dividend re-investment option the final amount remains the same as the growth option.
If we only consider the final amount, Dividend Re-Investment and Growth option have no difference.
Dividend Re-Investment Or Growth?
So if I have to select one, I will opt for growth option as my first preference and then opt for dividend payout option. If at any point in time if I want to be investing again, let the dividend be paid out and then invest it again manually.
The Benefit of Dividend Re-investment
If there would have been no dividend distribution tax for mutual funds, dividend re-investment would have made a smarter choice than growth option.
Let me explain how.
Let us assume that there is a 25% increase in nav for both growth and dividend option after the dividend was paid at ₹12.
So the NAV for the growth option becomes increased from ₹12 to ₹15 and for the dividend (payout or re-investment) the NAV increases from ₹11 to ₹13.75.
At this point investor wishes to redeem.
So in growth option, his profit is ₹5,000. Invested ₹10,000 and redeems ₹15,000.
In Dividend re-investment, his purchase is 10,000 as initial investment + 1,000 as dividend re-invested amount.
So his sale price is 13.75 x 1090.90 is again 15,000 but his gain is not 5,000 because his purchase price is 10,000+1,000.
Because there is a dividend distributed tax, the save in tax by the individual is paid by the mutual fund.
There isn’t one option to work for everyone and this is the reason so many options exist. Opt the one that best suits your requirement.