The choices for an investor while selecting the appropriate mutual funds are endless. One of the choices involves choosing between a growth or a dividend type of mutual fund. There are pros and cons to both the types and the option you choose depends on a number of factors like your financial status and investment portfolio.
Long-Term Vs. Short-Term Returns: When an investor selects the growth option in Mutual funds, it means that the amount invested does not yield returns on a monthly basis. Any principal that is invested is reinvested until the end of the term of the investment. Thus, the Growth option is more suitable for investors who are looking for long-term investment and not those who depend on their portfolio for a reliable source of monthly income. On the contrary, the investors who choose to go with the dividend option will receive more frequent payouts and do not have to wait until the end of their investment period.
Tax Benefits: The taxation policies on mutual funds depends on the type of fund you choose. Technically equity funds and debt funds are both tax-free for the investors. But dividends of the debt funds have to bear DDT (Dividend Distribution Tax) charge which is taken from the Net Asset Value ( NAV) of the fund. This can range from as large as approx 27% for individual investors to 32% for corporate investors for money market funds and liquid funds. If you choose to go with the growth mutual funds, you will only have to pay a marginal tax depending on your tax slab. For, long-term investments of more than a year, you will only have to pay a tax of 15% without any indexation. Thus, a growth debt option will be the best for those looking to avoid tax incidence.
Risk Of Return: Growth Equity funds have a higher chance of a good return if done as a long term investment but are risky as a short term investment. The appreciation of value happens as the principal is reinvested until it gives a sizeable income and your portfolio value rises over time. Dividends are comparatively risky as an investment option unless done carefully as the company does not always declare a dividend for the whole year. The payouts in this option are quite irregular but are tax-free when in the hands of the investors. Dividend funds are great for a short term fund of the debt option as they will have a greater chance of giving regular returns.
NAV: With Growth based funds, the NAV is usually higher which leads to an increase in capital over the long term. Since no dividends are paid out, the amount keeps on increasing exponentially over the years and is quite a good amount when it is time to redeem it. In most cases, this is not dependent on the performance of the fund but it is due to the increase in the capital because of non-payment of dividends. This leads to quite an increase in the Net Asset Value or the NAV of the investor. In contrast, the NAV does not increase by much in the case of funds which give out dividends. Since you keep receiving the dividends at regular intervals, your capital keeps going back to the initial amount after every payout.
To summarize, the type of investment that you choose depends heavily on your personal financial circumstances. If you need a continuous cash flow, then you should choose to go with a dividend based mutual fund investment but if you are interested in increasing your portfolio and have extra money to spare then you should go for Growth based mutual funds. There are also several mutual fund investment options which combine the features of both these types of funds. There is no right or wrong investment when it comes to mutual funds but the choice depends on which fund is right for you and your economic circumstance. In case you are still not sure about which investment to choose then the best option might be to consult your financial advisor who can guide you in the right direction.