Growth vs. dividend
It's important to first get an overview of the two options before we venture into explaining why there is a discrepancy between them. Broadly, mutual funds have two options - growth and dividend. Under the dividend option, income generated by the mutual fund scheme on its investments is distributed to the investor. This income/dividend is not assured by the mutual fund and is linked closely to the performance of stock/debt markets. The investor can choose to either encash the dividend or re-invest it in the same mutual fund scheme (through the dividend re-investment facility).
Under the growth option, the investor does not receive an income; in this case the growth option NAV already reflects the growth in investments (if any) registered by the mutual fund. If the investor is in need of an income, he can redeem (either completely or partially depending on his investment objective) his units; the difference in the growth option between the time he bought the mutual fund and redeemed it is effectively his income.
The common perception
Investors believe that after the dividend is distributed, growth NAV and dividend NAV do not appreciate or depreciate in the same proportion. In other words they believe that since the growth NAV is higher than the dividend NAV, it has appreciated more than the dividend NAV. Therefore, they think that they are better off selecting the growth option as opposed to the dividend option. While there are several reasons why investors must choose a particular option (growth or dividend), this is certainly not one of them, mainly because the reality behind the discrepancy between the two options is far from the perception. To know when to select which option, read our article on this subject:
Don't fall for the dividend bait
What happens when dividend is declared
Once a dividend is declared by the mutual fund, the dividend option NAV diminishes to the extent of the dividend declared. The growth option NAV on the other hand remains unchanged (for simplicity's sake we have ignored the market movement on that particular day). The diminution in the dividend option NAV equals the amount of dividend declared.
A matter of dividend
| Growth | Dividend | ||
| NAV as on January 1, 2007 | Rs | 10.0 | 10.0 |
| NAV as on March 30, 2007 | Rs | 12.0 | 12.0 |
| Dividend declared as on March 31, 2007 | % | - | 10.0 |
| NAV as on March 31, 2007 | Rs | 12.0 | 11.0 |
| NAV growth over 1-month | % | 10.0 | 10.0 |
| NAV as on April 30, 2007 | Rs | 13.2 | 12.1 |
For instance, in our illustration (refer table) both the growth and dividend NAVs have appreciated by 20% from the NFO (new fund offer) period to close at Rs 12.0. The mutual fund declares 10.0% dividend after which the dividend NAV declines to Rs 11.0 (ex-dividend). The growth NAV on the other hand remains unchanged at Rs 12.0.
The difference between the growth and dividend NAVs will equal the dividend declared (i.e. Re 1). However, the difference in both the NAVs will equal the dividend declared only on the day of the dividend declaration. The next day this difference will vary (from Re 1 in this case) based on the market movement. For instance, lets assume that markets appreciate by 10% over 1-month after the dividend declaration. In that case, the growth option will rise from Rs 12.0 to Rs 13.2, while the dividend option will rise from Rs 11.0 to Rs 12.1.
The 10% growth in NAV is based on the value of the portfolio's investments. Therefore, although the growth NAV seems higher compared to the dividend NAV, both NAVs have appreciated proportionately. The difference between the options is now Rs 1.1 while at the time of the dividend declaration it was Rs 1.0.
What investors should do
As we have impressed no matter what option the investor chooses, dividend and growth NAVs will appreciate/deprecate based on the market movement; there is no other factor at play over here. Which option (growth or dividend) to select is dictated entirely by the investor's investment objective and income/liquidity constraints.
By Personalfn.com
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