In this section, we shall start with two categories of mutual funds that most investors bear in mind while managing their portfolios: growth mutual funds and dividend mutual funds. Each of these types of funds is advantageous in its own way based on what exactly the investor is looking to achieve, how the funds are structured, and the duration they are supposed to be held. In this article, we shall analyze the nature and compare the benefits of each category of a mutual fund to enable you to choose the one that best meets your financial requirements.

Growth mutual funds work on the principle of capital appreciation and are mostly used for mid and long term investment horizons. Here’s a closer look at their structure and key features Mutual Funds are a type of investment in the capital market that aggregates the money of different people and invests it in a target market, therefore gaining social diversification.

Growth Mutual Funds

So what is a growth mutual fund? Growth Funds are geared toward accumulating principal value, so their returns are sustained by net asset value appreciation instead of profit distribution. In a profit distributed/ accumulation growth fund, dividends and profit share are termed as income to the fund holders are paid instead of reinvested.

Value and Growth

As is the case with every growth mutual fund, its value appreciates as the investment grows. This increment is a result of the market returns and the skillful execution of the fund manager in dealing with the stocks in the portfolio. As time goes by, the value of the fund improves through capital appreciation and profit reinvestment, resulting in enhanced returns.

The growth of this fund is dependent on many factors such as:

• The skill level of the fund manager.
• The overall returns from the stocks.
• The retention period of the asset by the investor.

Dividend Mutual Funds

Dividend mutual funds, in contrary, share the profits earned by mutual funds with the investors in the form of dividend distributions. Let us see how they perform.

Income Passed to Investors

Profits are shared among the investors in a dividend mutual fund whenever the mutual fund reports a profit from its operations. This profit may arise from:

• Growth in the value of the shares of the stocks in the mutual fund.
• Dividends from the stocks in the funds portfolio.

For example, if a mutual fund price is Rs. 300 and a Rs. 6 dividend is paid, the mutual fund Net Asset Value (NAV) would reduce to Rs. 294. This implies that the shares held by the fund are liquidated to enable payment of dividends which restricts the potential of the fund.

Income at Regular Intervals

Most dividend mutual funds distribute income at specified intervals. This could be once a year, quarterly, or as frequently as every month. The payment of the dividend has no set value nor does it have a compulsory payment schedule. It is dependent on the performance of the fund and the state of the market.

No Assurance of Amount or Timing

Another key feature of dividend mutual funds is that there is no assurance of the magnitude of and the timing of the dividends. Many funds have a policy of paying dividends but the amounts vary from year to year depending on the portfolio performance which is dominated by stock price changes.

Growth vs. Dividend Mutual Funds: A Brief Review

Like other types of mutual funds, growth and dividend funds also have unique features that distinguish them from each other. Let us analyze them against important factors:Profit Distribution Vs Reinvestment.

Growth mutual funds utilize profits by distributing them among investors instead of withdrawing funds, which results in increasing the fund’s value over time.

Dividend mutual funds return profits to investors, which restricts the potential of the fund growing since the profits are used to pay dividends.

Return Potential

As stated before, growth mutual funds tend to do better than other funds in the long term during the reinvestment phase of profits.

Dividend mutual funds, on the other hand, grant regularly scheduled lower profits over the years primarily due to the absence of reinvesting the profits gained from the fund.

Taxation

In growth mutual funds, profits made are subject to taxation of profits on capital gains which depends on how long the asset was kept. In this case, short term capital gains are taxed at 15% while long-term capital gains are taxed at 10%.

In dividend mutual funds, the dividend paid out is considered as income of the investor and he may end up paying more tax on income than before thus lowering the value of return he receives.

Choosing Between Growth and Dividend Mutual Funds

Investors must consider several important factors before selecting growth or dividend mutual funds.

Financial Goals and Objectives

If you are a young investor trying to build wealth over time, growth mutual funds are most likely you’re your best option. These funds with the reinvestment of profits usually outperform in the long run.

If you are close to retirement or require consistent income from your investments, dividend mutual funds may be more appropriate, as they do pay out consistently.

Age and Investment Horizon

Young investors with a regular income who have a long-term investment period should generally prefer growth mutual funds. There compounds on these funds lead to significant wealth accumulation over the years.

Dividend funds may appeal more to older investors or those nearing retirement than growth funds as these investors are in need of a steady stream of income.

Direct Vs Regular Plans

One more thing to consider while investing in mutual funds is whether to choose a direct plan or a regular one. Returns are usually higher in direct plans because there are no intermediary charges. Thus, for the sake of long term growth, investors should choose direct growth plans since these allow them to achieve maximum returns.

Conclusion

When choosing growth mutual funds versus dividend mutual funds, consider your objectives, current age, and preferences when it comes to investing. Dividend funds are more appropriate for people at the latter stages in life which is the opposite for growth funds which target individuals looking for long-term benefits.

For young investors, growth mutual funds have a higher YTM because of increases in capital or reinvesting profits within the funds. On the other hand, dividend mutual funds provide more return security, although at lower potential yields if one is nearing retirement or if the individual prefers steady payouts over a long period of time.

The decision making process requires careful consideration of one’s tax position, capital outlay required, market strategy, and even one’s time horizon. The importance of both funds is understood, however, their long-term impact on one’s financial situation will depend on the selection chosen.