While investing in an equity mutual fund (MF), you get to choose between two options: growth and dividend. In the dividend option, when the fund declares a dividend, you can either opt for a payout (you get dividends in hand) or reinvest the dividend back into the scheme by buying new units for the amount of dividend declared. The latter one is called the dividend reinvestment option. You need to choose your option at the time of making your investment.
In the growth option, your net asset value (NAV) keeps going up or down depending on market movements; you don’t get dividends in hand. But whether you choose the dividend reinvestment option or the growth option, it makes no difference.
How it works
The growth option: Assume that the NAV of an MF scheme is Rs 10 per unit and you invest Rs 1 lakh. You will receive 10,000 units of the scheme. Suppose the NAV of the scheme doubles in one year to Rs 20 per unit. And in the second year, it further doubles to become Rs 40 per unit. Now, the value of your investment at the end of the second year rises to Rs 4 lakh. If you redeem your investments, you will gain Rs 3 lakh (Rs 4 lakh-Rs 1 lakh). Since, equity investments do not attract any capital gains tax if invested at least for a year, this will be your net gain.
Dividend reinvestment option: Here too you invest Rs 1 lakh at an NAV of Rs 10 per unit and get 10,000 units of the scheme. Suppose the NAV doubles in one year and rises to Rs 20 per unit. The value of your investment will increase to Rs 2 lakh. At this point, the scheme declares a dividend of Rs 5 per unit. The total dividend due to you will be Rs 50,000. The dividend amount will not be given to you and instead will be reinvested into the scheme.
Also, post-dividend, the NAV of the scheme will fall by the same value. Hence, the NAV after dividend will be Rs 15 (Rs 20-Rs 5) and you will receive 3333.33 units (Rs 50,000 divided by 15; additional units are always allotted at discounted NAV). So your total units go up to 13,333.33. Now, again assume that NAV doubles again in the next one year and it becomes Rs 30 per unit. Thus, the value of your investment will be approximately Rs 3,99,999.90 (13,333.33 units x Rs 30). So in this case too, your gain is Rs 3 lakh. Again, this amount will be a net gain as the investment was held for two years. Hence in this option, though the NAV will lag behind that of the growth option, the number of units would keep increasing. The other way of looking at it is that under the dividend reinvestment plan, you keep on accumulating more units, but in a growth plan, your NAV sees a higher growth but the number of units remain the same.