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Mutual funds offer investors different options to suit their financial goals. Two popular choices are the dividend option and the growth option. Knowing the difference between these options helps you make better investment decisions.
This blog will explore the differences between growth and dividend mutual funds.
What is a Growth Mutual Fund?
Growth mutual funds focus on increasing the value of your investment over time. When you invest in a growth mutual fund, the profits earned are not paid to you. Instead, they are reinvested back into the fund. This reinvestment helps your investment grow faster because you earn returns on your returns.
Growth mutual funds are ideal for people who don’t need regular income from their investments and are looking to build wealth over a long period.
They are suitable for long-term financial goals like retirement or children’s education. The key benefit is the potential for higher returns, although it also comes with higher risks.
Growth mutual funds can be a smart choice for investors willing to stay invested for several years to benefit from the power of compounding.
What is a Dividend Mutual Fund?
A dividend mutual fund pays out the profits it earns to investors regularly. When you invest in a dividend mutual fund, the fund earns profits from its investments, which are distributed as dividends. These dividends can be received as cash or reinvested to buy more fund units.
Dividend mutual funds are suitable for people who want regular investment income. This makes them ideal for retirees or anyone looking for a steady cash flow. While the returns may be lower than growth mutual funds, the regular payouts provide financial stability.
Dividend mutual funds are a good choice for investors seeking consistent income without selling their investments.
Difference Between Dividend and Growth Mutual Funds
| Feature | Growth Mutual Fund | Dividend Mutual Fund |
| Primary Focus | Capital appreciation over the long term | Regular income through periodic dividends |
| Distribution of Profits | Profits are reinvested into the fund to increase its value | Profits are distributed to investors as dividends |
| Investor Profile | Investors looking for long-term growth | Investors seeking regular income |
| Tax Implications | Taxes are incurred only when you sell your units (capital gains tax) | Dividends are taxed as per income tax slabs |
| Risk vs Reward | Generally higher risk due to market fluctuations, but potentially higher returns | Lower risk compared to growth funds, but typically lower returns |
| Flexibility | Limited liquidity as profits are reinvested | Offers liquidity with regular dividend payments |
Tax Implications
Understanding the tax implications is crucial when investing in mutual funds, as it can impact your overall returns. Here’s how taxation works for growth and dividend mutual funds:
Growth Mutual Funds Taxation
Growth mutual funds are designed for long-term capital appreciation. Here’s how they are taxed:
In growth mutual funds, you earn returns when the value of your investment increases over time. These returns are considered capital gains and are taxed accordingly. There are two types of capital gains:
1. Short-term Capital Gains:
If you sell your mutual fund units within three years of purchase, the gains are classified as short-term capital gains (STCG). Short-term capital gains are taxed at your applicable income tax slab rate.
2. Long-term Capital Gains:
If you sell your mutual fund units after three years of purchase, the gains are classified as long-term capital gains (LTCG). Long-term capital gains on equity mutual funds exceeding Rs. 1 lakh in a financial year are taxed at 10% without indexation benefit.
Dividend Mutual Funds Taxation
Dividend mutual funds are designed to provide regular income through periodic dividend payouts. Here’s how they are taxed:
When the mutual fund declares a dividend, it is subject to Dividend Distribution Tax (DDT) before being paid out to investors.
DDT has been abolished, and dividends are taxed by investors according to their applicable income tax slab rates. This means dividends are added to your annual income and taxed accordingly.
It’s important to note that the tax implications for both types of mutual funds can vary based on changes in tax laws and your tax situation.
Seeking a tax advisor or financial planner will help you understand the tax implications and optimise your investment strategy accordingly.
Which Mutual Fund Option is Better: Growth or Dividend Mutual Fund?
Deciding between growth and dividend mutual funds depends on your financial goals and preferences.
Growth mutual funds focus on increasing the value of your investment over time. The profits made by the fund are reinvested to grow your investment further. This compounding effect causes significant returns in the long run. However, it requires patience as you won’t receive regular income in the form of dividends.
Dividend mutual funds regularly distribute part of their earnings as dividends to investors. These dividend payments offer a consistent source of income, which is beneficial for individuals seeking regular cash flow or opting for a more reliable investment option.
While dividend mutual funds may grow slower than growth funds, they offer the benefit of immediate income.
Growth mutual funds might be better if you want to build wealth over the long term and can afford to wait for more significant returns. On the other hand, if you need income regularly or prefer a lower-risk investment, dividend mutual funds suit you better.
Ultimately, the best mutual fund option depends on your financial situation, goals, and investment timeline. Seeking advice from a financial advisor enables you to make better decisions that match your requirements.
Conclusion
Choosing between dividend and growth mutual funds depends on your financial goals. Growth funds are suitable for long-term capital appreciation, while dividend funds are ideal for those needing regular income.
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