Difference between Dividend and Growth

Simply put

In a growth plan, the gains made by the scheme are reinvested. Therefore, the net asset value (NAV) moves up. In a dividend plan, the gains are periodically distributed as dividend. So the NAV drops to the extent of the dividend, whenever it is paid out.

Dividend reinvestment is a facility to put the dividend back into the scheme, buying up some more units. Dividends are tax free, whereas an investor who sells his or her units to earn the gains will have to pay capital gains tax on the gains, depending on the holding period.

Therefore, investors who need income should choose dividend plan, and investors who can hold for longer period, should choose the growth option.

In an equity fund, gains realized after one-year holding period are also not taxed.

Deep Dive

The common perception

Investors believe that after the dividend is distributed, growth NAV and dividend NAV do not appreciate or depreciate in the same proportion. In other words they believe that since the growth NAV is higher than the dividend NAV, it has appreciated more than the dividend NAV. Therefore, they think that they are better off selecting the growth option as opposed to the dividend option. While there are several reasons why investors must choose a particular option (growth or dividend), this is certainly not one of them, mainly because the reality behind the discrepancy between the two options is far from the perception. To know when to select which option, read our article on this subject:

What happens when dividend is declared
Once a dividend is declared by the mutual fund, the dividend option NAV diminishes to the extent of the dividend declared. The growth option NAV on the other hand remains unchanged (for simplicity’s sake we have ignored the market movement on that particular day). The diminution in the dividend option NAV equals the amount of dividend declared.

A matter of dividend

		Growth	Dividend
NAV as on January 1, 2007	Rs	10.0	10.0
NAV as on March 30, 2007	Rs	12.0	12.0
Dividend declared as on March 31, 2007	%	-	10.0
NAV as on March 31, 2007	Rs	12.0	11.0
NAV growth over 1-month	%	10.0	10.0
NAV as on April 30, 2007	Rs	13.2	12.1

(We have assumed that the growth and dividend options have similar portfolios. If they have different portfolios then the discrepancy will be due to a combination of market movements and their respective portfolios. For simplicity’s sake we have ignored the market movement on March 31, 2007)

For instance, in our illustration (refer table) both the growth and dividend NAVs have appreciated by 20% from the NFO (new fund offer) period to close at Rs 12.0. The mutual fund declares 10.0% dividend after which the dividend NAV declines to Rs 11.0 (ex-dividend). The growth NAV on the other hand remains unchanged at Rs 12.0.

The difference between the growth and dividend NAVs will equal the dividend declared (i.e. Re 1). However, the difference in both the NAVs will equal the dividend declared only on the day of the dividend declaration. The next day this difference will vary (from Re 1 in this case) based on the market movement. For instance, lets assume that markets appreciate by 10% over 1-month after the dividend declaration. In that case, the growth option will rise from Rs 12.0 to Rs 13.2, while the dividend option will rise from Rs 11.0 to Rs 12.1.

The 10% growth in NAV is based on the value of the portfolio’s investments. Therefore, although the growth NAV seems higher compared to the dividend NAV, both NAVs have appreciated proportionately. The difference between the options is now Rs 1.1 while at the time of the dividend declaration it was Rs 1.0.

What investors should do
As we have impressed no matter what option the investor chooses, dividend and growth NAVs will appreciate/depreciate based on the market movement; there is no other factor at play over here. Which option (growth or dividend) to select is dictated entirely by the investor’s investment objective and income/liquidity constraints.

Happy Investing


Sources : EquityMaster & Wikipedia