Riya and Aman, both 30-year-old professionals, recently began investing into mutual funds. Riya focused on building long term wealth for her new home and retirement and she chose the growth option. Aman, who supports his aging parents and prefers a regular income stream, chose the dividend (IDCW) option. One year later they are both invested in the same mutual fund, but their returns, experience, and ultimate results are completely different.

This isn’t just their story, this is a very real situation for most investors. You choose a fund thinking you have made the right choice, but overlook that choosing between growth and a dividend option can change the entire nature and effectiveness of your investment. The good news is that once you understand the difference you will find it easy to find a choice that is right for you whether that is to build your wealth or for some income stream.

The choice between growth and dividend is not a question of which is better overall, but which is better for you. Are you effectively building wealth quietly over time, or do you have a need for consistent income from your investment to manage monthly expenses to achieve short term objectives? 

In the sections below, we break down the two options, compare their positives and negatives, and assist you to select which option suits your financial journey.

What is a Growth Mutual Fund?

When you invest in a mutual fund through a growth option, all returns—whether they are dividends, interest, or capital gains—will be reinvested into the fund. As such, the Net Asset Value (NAV) will increase over time, as your wealth grows quietly in the background.

During the investment period, you do not receive any cash outlays. Your investment is accruing value, and you only get to realize a capital gain when you sell the fund units. For this reason, the growth mutual fund option is suitable for long-term goals such as; the purchase of a house, retirement planning, and the build-up of a child educational corpus.

What is a Dividend Mutual Fund?

In the dividend option, which has now been renamed by SEBI to income distribution cum capital withdrawal (IDCW), the mutual fund distributes a portion of its profits to its investors based on specific rules. The payout may be as often as monthly, quarterly, or annually. With each payout, the NAV reduces equivalently for each investor.

Most importantly to remember with dividends is they do not create additional returns, the dividend is just a portion of profits from your investment being distributed to you instead of being re-invested to increase your holding in the fund.

Key Differences Between Growth and Dividend Mutual Fund Options

Understanding the difference between growth and dividend mutual fund options is crucial because it will clearly impact how returns are made to you, how your investment grows, and how your taxes will be assessed. 

Here is a brief overview of a few differences:

1. Treatment of Returns: 

• Growth Option: As a growth option all income, whether from dividends declared from the stock components in the fund’s portfolio, interest income from credit market instruments, or a capital gain, is reinvested in the scheme, you never actually receive or realize returns in cash during the investment period. You benefit from the fund’s Net Asset Value (NAV) constantly increasing over time (indirectly) from reinvested gains. For long-term investors, this greatly contributes to wealth accumulation over time.

• Dividend (IDCW) Option: In this option, the fund actually distributes some of its earnings periodically. While fund houses periodically distribute dividends, which may be described as “income?”, fund houses can and do distribute dividends from capital you invested into the fund when they believe equity markets may not be favourable. 

2. NAV (Net Asset Value) Movement

• Growth Option: In a scheme where there are no payouts, the NAV in growth plans moves upwards steadily as profits are accumulated. There are no big dips as the profits are paid out, so the growth curve is much more consistent. Therefore, investors have a clearer view of how the wealth is compounding over time.

• Dividend Option: NAVs in dividend plans are more volatile as they fall with each dividend declared. It is harder to assess growth, and it may be misleading for investors to assess growth purely based on NAV without considering the receipts of dividends.

3. Compounding Effect

• Growth Option: The growth option offers you the maximum benefit from compounding as all profits remain in the fund. This creates the snowball effect of earning returns on both the original capital and what the original capital has earned over time. The longer you stay invested, the more pronounced the snowball effect.

• Dividend Option: Dividends provide liquidity, however, in doing so takes away the compound effect. When you apply bitcoin, consistently withdrawing income from the remaining corpus earns you less and decreases the long-term potential for wealth creation. Compounding is an inherent benefit of being able to put your entire investment duration corpus to work, requiring you to manually reinvest those withdrawals into the fund – with added risk of paying more fees!

4. Income & Liquidity

• Growth Option: This option is a good fit for those who would not receive any periodic income during the investment period, therefore making it a good fit for people with a consistent source of income, looking to raise wealth accumulation over time; for example, a professional contributing towards retirement, a child’s future education, or future home purchase.

• Dividend Option: This option is a good fit for those who would like some periodic cash flow – these might be retirees or others without a consistent source of income, where the withdrawals may act as a passive income in a form. The officer period of time and amount can fluctuate at the AMC’s discretion, based on the fund’s surplus, so do not expect guaranteed amounts or at regular fixed periods.

5. Suitability for Financial Goals

• Growth Option: The growth option satisfies the needs of letting time help financial goals where the goal is wealth creation and cash flow is not needed on a regular basis – for example: build a corpus for retirement, children’s future education, plans for early financial freedom.

• Dividend Option: The dividend option is better suited to someone needing short – medium term cash flow needs or someone needing a top-up to existing income, hence this option is often preferred by people in ‘post-retirement’ living or for people who rely on ‘dividends’ in living expenses.

6. Flexibility and Planning

• Growth Option: You can manage the time of when you are redeeming units allowing you to manage any tax and the cash flow in relation to your financial plan. You have more predictability whenever planning for your goals since you can put the entire corpus to work every time, without interruption.

• Dividend Option: Any payouts or distributions are based upon the fund manager’s decision, not yours. It is also very difficult for you to plan expenses throughout budgeting, as the timing and amounts of income are left to your fund’s discretion. Further, income is not guaranteed from the distributions and funds may cease payment from the fund performance.

When Should You Use Growth Instead of Dividend?

If you are looking to build long-term wealth and do not need regular income, choose the growth option. This option is also great for young people just starting their careers or anyone who is saving for future goals such as retirement or child’s education. Because all returns are reinvested the compounding can do a better job.

The dividend (IDCW) option is more suitable for people needing periodic income – retirees, or homemakers. Dividend funds generate cash flows, but you can never expect a guaranteed payout, and payouts are taxed based on your slab, so returns are, typically, reduced after taxes are taken into account.

If you have a mix of needs, you can do both; use growth funds for long-term investing and dividend funds to provide some liquidity.

Common Mistakes to Avoid When Choosing Between Growth And Dividend Options

Many investors chase dividends without realizing they reduce NAV and are taxed as regular income. Others ignore the growth option’s tax efficiency, especially for long-term goals. Some focus only on past returns, not total returns (NAV + dividends), while others miss out on compounding by not reinvesting payouts. The biggest mistake? Choosing an option without aligning it to personal financial goals.

Conclusion

Growth and dividend (IDCW) options in mutual funds satisfy different investor needs. If you want the ability to build wealth over time, make the growth option your choice, as compounding will help grow your investment faster over the long run. If you need income, the dividend option can fill in the gaps in cash flow, but does not build wealth as well because there will be less compounding.

FAQs

Which option has better returns – growth or dividend?

The growth option normally has better returns over the long run because the fund will reinvest its profits and also benefit from compounding.

Are dividends from mutual funds guaranteed?

No. Dividend distributions are made at the discretion of the fund house based on fund performance and are not guaranteed.

Can I switch between growth and dividend options?

You can switch options, but it may be treated as a redemption and new investment which may trigger capital gains tax.

How are growth and dividend options taxed?

The growth option gains will be taxed at the point you redeem your units. Dividend distributions will be included in your total income and be taxed warranting your slab rate.

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