Growth Vs. dividend reinvestment, which is better for you? 3 point agenda

Growth Vs. dividend reinvestment, which is better for you? 3 point agenda

An investor has several alternatives when it comes to selecting a mutual fund. One of the most baffling decisions is whether to invest in a fund with a growth option or one with a dividend reinvestment option. Each type of fund has benefits and drawbacks, and which is a better fit for you as an investor, will be determined by your individual needs and circumstances.

Dividend and growth mutual funds are the two main types of mutual funds available to investors. According to experts, investors should select either option based on their financial goals. Before deciding on one of the two choices, consider the tax consequences. The main difference between dividend and growth options is that in the former, the mutual fund’s earnings are given back to investors at regular intervals, whilst in the latter, they are reinvested in the plan.

When you invest in a Mutual Fund plan, you are always given two choices. One option is to let the scheme’s profits be reinvested. Two, you can choose to get your investment returns on a regular basis. The Growth Alternative of a Mutual Fund Scheme is one option, while the ‘Income Distribution cum Capital Withdrawal’ plans, or IDCW plans, are the other (Earlier known as Dividend Plan).

If you don’t want to accept your dividends, you can pick between a growth option or a dividend reinvestment option with mutual funds.
A growth option allows the fund operator to invest dividend payments in more assets, allowing the investor’s money to expand.

Dividend reinvestment allows fund managers to utilize dividend payments to acquire new shares in the fund on the investor’s behalf.

Individual retirement account (IRA) holders are unable to receive dividend distributions prior to retirement without incurring penalties and must instead choose to reinvest.
As a result, investors who want a monthly income from their mutual funds typically pick the IDCW Plan. The Growth Plan, on the other hand, is preferred by investors who wish to profit from long-term wealth appreciation, notably through equities investment, because all fund returns are reinvested.

Apart from these two programs, there is also a third option known as ‘IDCW Reinvestment’ (formerly known as Dividend Reinvestment Plan). This option isn’t offered in every mutual fund scheme, and it’s only available in a handful. Returns or dividends are announced by a scheme but not paid out to you in this Reinvestment of IDCW plan. Instead, when a dividend is declared, the returns are reinvested at the fund’s NAV.

The dividend option pays out the mutual fund scheme’s earnings to investors at regular periods such as annual, daily, monthly, quarterly, and so on. Instead of paying out gains to investors, the plan’s profits are reinvested in the scheme in the growth option.
However, the portfolio of the fund stays the same in both scenarios.

“Both the dividend and growth options have the same underlying portfolio. When a fund manager makes a profit, the impact on both dividend and growth choices is the same. The only difference is that gains are reinvested in the growth option rather than dispersed in the dividend option, according to Dr. Ravi Singh, Head of Research and Vice President of ShareIndia.

The NAV will be larger under the growth option, according to Vinit Khandare, CEO and Founder of MyFundBazaar, since the reinvested gains may make profits. In addition, the overall return on the growth choice is larger.

“In the dividend option, the fund manager’s gains are dispersed to investors. The dividends paid are subtracted from the NAV, resulting in a reduced ex-dividend NAV. While the overall returns would be smaller, in the long run, owing to periodic distributions, taxes will be based on the investor’s income tax bracket rate,” Khandare told FE Online.

Profits earned by the fund management are reinvested in the plan in the growth option. The NAV will be larger than the Dividend Option since earnings reinvested may yield profits. Also, over a suitably long investment horizon, total returns will normally be larger than dividends,” he noted.

The growth option, according to Anurag Garg, Founder, and CEO of Nivesh.com, allows you to make profits on profits and hence benefit from compounding because the gains are reinvested in the plan.

What exactly are these plans?

A growth plan is the most basic sort of plan in which the unitholder receives no remuneration. Any dividends or capital gains you get are reinvested in your fund, ensuring that the NAV of the growth plan increases in lockstep with the market. Dividends are paid out in cash to unitholders in a dividend scheme.

This is excellent if you’re searching for a steady stream of income from mutual funds. Your fund’s NAV will drop to the degree that the dividend is paid out. A dividend reinvestment plan is a hybrid investment strategy that incorporates the advantages of both dividend and growth investing.

The announced dividend is not paid out in cash in the dividend reinvestment but is instead reinvested in the same fund’s units. The dividend paid out attracts a dividend distribution tax (DDT) of 28.33 percent in the case of dividend plans and dividend reinvestment plans of Debt Funds.

Mutual Funds With a Growth Option

The growth option of a mutual fund means that an investor will not receive any dividends paid by the mutual fund’s assets. Some shares pay out regular dividends, but picking the growth option allows the mutual fund company to reinvest the money that would otherwise be paid out as a dividend. As a consequence of this money, the mutual fund’s net asset value (NAV) increases.

The growth option is not a good alternative for investors who wish to get regular cash payments from their holdings. It is, nevertheless, a strategy for increasing the capital gain on the same number of shares bought when mutual funds are sold by optimizing the fund’s NAV. This is because the fund business spent all of the dividends that would have been paid out to invest in new companies and expand the money of its investors. The investor does not receive additional shares in this situation, but the value of existing fund shares increases.

The IDCW Reinvestment Plan may appear to be similar to the Growth Plan on the surface, but they are very different in terms of how they function and how they are taxed. In this article, we’ll go through all of the distinctions between the two solutions and determine which is the superior option.

In the case of a growth plan, if you buy mutual funds worth Rs. 50,000, where NAV is Rs. 10per unit. Thereby the total number of units is 5000.
After a year, the NAV rose to Rs. 15 per unit, and profit was Rs. 2 per unit totaling Rs.10,000.

So the total investment after a year comes to Rs. 65000 (5000*15) with the addition of the profit amount, i.e., Rs. 10,000. The total investment is Rs. 75000 while the number of units remains the same. No dividend is declared under this scheme.

Mutual Funds With a Dividend Reinvestment Option

Dividends are announced but not paid out in the ‘IDCW Reinvestment Option,’ as previously stated. Instead, they are reinvested at the fund’s NAV when the dividend is declared. As a consequence, you will receive additional units in the fund, increasing your investment capital. However, the Dividend Reinvestment Plan’s NAV is limited to the number of dividends paid out.

The dividend reinvestment choice differs significantly. Dividends that would have been paid to investors in the fund are instead used to purchase additional shares in the fund. The investor does not get cash when dividends on the fund’s stocks are paid out. Instead, the fund’s managers use cash to buy new fund units on behalf of investors and deliver them to their accounts.

This strategy gradually increases the number of shares owned, resulting in a quicker growth in account value than if dividends were not reinvested. Many investment firms provide this service for free to their shareholders.

When investors sell their fund units, they make a financial gain, which in the case of the dividend reinvestment option is likely to be more fund units than they started with.
Choosing a mutual fund with a dividend reinvestment option or a growth option means foregoing monthly dividend payments in favor of enabling the fund to spend that money to expand your assets.

Let’s look at an example to see how this works.

Assume you put Rs 50,000 into a mutual fund scheme with a NAV of Rs 10 per unit. As a result, the total amount of units you will receive is 5,000.

After a year, the mutual fund’s NAV grew to Rs. 15 per unit, and the plan declared an Rs. 2 per unit dividend. As a result, you will receive Rs. 10,000 in dividends (Rs. 5,000*2). And the entire value of the Dividend Reinvestment Plan or IDCW Reinvestment Plan is reduced to the degree that the dividend is withdrawn. As a result, the scheme’s NAV would drop by Rs. 2 to Rs. 13 from Rs. 15.

This Rs. 10,000 refunds will now be reinvested in your account. The new NAV is Rs 13 per unit, which implies you’ll receive 769.23 units (10,000 divided by 13). As a result, your total number of units in that scheme has increased to 5,769.23 (5,000 + 769.23). And a total investment of Rs. 74,999 (Rs 13* 5,769.23 units) would be made.

Who should opt Growth option?

Investors who do not want continuous cash flow should consider growth choices, according to experts. Because gains are reinvested in the plan, the NAV of growth options will be larger; investors may earn profits on profits and hence benefit from compounding. Over suitably long investment horizons, total returns will normally be higher than dividend choices.

For investors with a long investing horizon and a willingness to take risks, Garg recommended growth possibilities. This strategy may also be appropriate for people looking to build money. “Younger investors, such as singles or young couples with small children, will be better suited to this alternative,” he added.

Because there is no Dividend Distribution Tax, Khandare believes the growth option may be better for individuals in the 10% tax band. Because the reinvested in the growth option may rise in value over time, The dividend option’s NAV will always be higher than the growth option’s.

Who should opt Dividend option?

Investors that demand regular income flows from their investments, according to experts, should consider dividend possibilities. The dividend alternative, however, may have a lower post-dividend NAV.

“The NAV is reduced by dividends paid. As a result, the ex-dividend NAV is lower. Because of the periodic distributions, total returns will be lower in the long run compared to growth choices,” Dr Singh explained.

The dividend alternative, according to Garg, is preferable for those who are retired and no longer earning. It would also be appropriate for individuals who do not have a steady source of income.

Individuals in the 20-30% income band, according to Khandare, may benefit from the dividend choice. “The Dividend Option is preferable if an individual has a higher income bracket (20-30 percent and above) since the Dividend Distribution Tax is cheaper. “Capital gains tax will be applied to income and taxed according to the slab if debt schemes are held for less than a year,” he said.

“In other words, since dividends have become fully taxable in the hands of taxpayers, it would make sense for you to choose the dividend option if your total taxable income does not exceed Rs 5 lakh, for which you can claim a rebate under Section 87A, effectively making the dividends tax-free in your hands,” he added.

Which option can give more returns in the long run?

Because the profits are reinvested and interest is generated on the reinvested amount, compounding returns are possible. The investor receives their initial investment plus compounded interest. Because distributions are paid on a monthly basis in the dividend option, the final amount remaining is the principle invested,” Garg explained.

“For investors who do not require monthly income, the dividend choice may be fruitless because the money may sit idle in the bank account.” “With the growth option, investors don’t have to worry about reinvesting their dividends since they are automatically reinvested,” he noted.

Experts, on the other hand, suggest that deciding between the two options is a question of personal preference and needs. Whether you invest in equities or debt funds may have an impact on your final return.

The Tax Impact On dividend Reinvestment Plan And Growth Plan

All dividends received from Mutual Fund schemes after April 1, 2020, would be taxable in the hands of investors according to their tax bracket, according to new income tax laws. Furthermore, if you reinvest dividends in the same mutual fund scheme, the income tax regulations do not provide any relief. Even if you do not get the dividend in your bank account, you must pay tax on it since the income tax agency considers dividends to be taxable income.

As a result, if you are in the 30% tax band, you will pay 30% tax on the dividends announced under the IDCW Reinvestment Plan in a given fiscal year. As a result, your mutual fund returns will be reduced even further.

Furthermore, if the payout amount exceeds Rs. 5,000, a 10% TDS is levied on dividends distributed by Mutual Fund schemes. This means that in the previous example, the amount reinvested will be smaller due to the TDS on mutual fund income. As a result, the eventual value of investments will be decreased as well.

According to Singh, the dividend option is taxed at the investor’s income slab rates. The tax ramifications for the growth option, on the other hand, begin when the fund is redeemed.

“In the event of a resident individual, the Income Tax Act mandates a 10% TDS deduction from dividend income.” If the total dividend received or projected to be distributed to an individual unit holder during the financial year does not exceed Rs 5,000, no TDS is deducted. The TDS rate would be 20% if there was no Permanent Account Number,” Singh explained.

“If you don’t redeem, there is no taxation on growth possibilities.” Short-term capital gains (those held for less than 12 months) are taxed at 15%, whereas long-term capital gains (those held for more than 12 months) are tax-free up to Rs 1 lakh and afterwards taxed at 10%. Short-term capital gains (kept for less than 36 months) are taxed according to the investor’s income tax bracket, while long-term capital gains (held for more than 36 months) are taxed at 20% after indexation advantages,” he explained.
Selecting a Dividend Distribution Option

In most circumstances, it is up to shareholders to decide whether dividends should be reinvested or paid out. Individual retirement funds would be an exception to this rule (IRAs). Dividends in IRA accounts must be reinvested by shareholders who have not yet achieved retirement age in order to avoid the Internal Revenue Service’s early withdrawal penalty (IRS).

Dividend Pay-outs

Dividend payments produced by the mutual fund are paid out directly to the shareholder in a dividend payout scenario. Dividends are usually deposited directly into a cash account, sent electronically to a bank account, or mailed out via check if the shareholder wishes. In most circumstances, shareholders do not pay any fees if their dividends are received in cash rather than reinvested in the stock.

Whether dividends are reinvested or paid out has no impact on their tax ramifications.. Dividend distributions are considered the same way in both situations in terms of taxation.

3 Points Agenda: Which Plan Should You Prefer?

Here are some helpful hints on how to go about choosing your plan: –
Growth plans are the ideal for long-term financial planning. Compounding works in your benefit since you immediately reinvest the money back into the fund. That is also appropriate for your needs.

What about the fiscal implications? Let’s take a look at several equity funds. If you invest in growth funds, you will pay a 15% tax rate on short-term capital gains (held for less than 1 year). If your long-term capital gains (kept for more than a year) reach Rs.1 lakh in a fiscal year, you will now be taxed at 10% without indexation. Dividends from dividend funds will be tax-free in the hands of the investor, but will be subject to a 10% DDT. In terms of tax management, this makes development plans more appealing.

In the event of debt fund growth plans, STCG (less than 3 years) will be taxed at the highest rate, while LTCG (after indexation) would be taxed at a rate of 20%. The DDT on debt fund dividend distributions is 25% plus surcharge and cess. A systematic withdrawal plan (SWP), which is more tax efficient, is a better option.

A shareholder can opt out of both the growth and dividend reinvestment choices and have the dividends paid out straight to them; in this case, the money is paid out to the investor immediately.

Both the IDCW Reinvestment and Growth plans reinvest the mutual fund scheme’s returns in order to gain higher returns and take advantage of compounding.

The main difference between the Growth Plan and the Dividend Reinvestment or IDCW Reinvestment plans is that the Growth Plan is more tax-efficient. So, if you want to reinvest your money and benefit from compounding, you don’t have to go through the hoops of Dividend Reinvestment or IDCW Reinvestment. Instead, use the Growth Plan to automate the reinvestment process. That’s all there is to the solution.

There is no such thing as a one-size-fits-all mutual fund, which is why there are so many to select from. Before investing, it’s a good idea to research a mutual fund’s individual qualities to ensure you don’t wind up with a fund that doesn’t satisfy your specific growth or cash-out requirements.