Growth vs. Dividend Reinvestment Mutual Funds: Which Should I choose?

Published: August 17, 2015 at 6:00 am

Last Updated on

Here is a simple illustration that will help you understand how growth and dividend-reinvestment  mutual funds work. You can use it to decide which is better for you, taking into account the investment duration and your tax-slab.

This is a re-publish taking into account changes made after budget 2014.

When a mutual fund offers regular (typically)  dividends  on daily/weekly/monthly/quarterly basis, the NAV falls to a  base value (Rs. 10/11/12 per unit) or close to it after each dividend.

Only debt or arbitrage mutual funds can afford to do this regularly. Therefore, what follows does not apply to diversified equity funds. Please tag such funds to a financial goal and always use the growth-option.

When a debt fund pays a dividend, the fund house will deduct a tax known as dividend distribution tax (DDT)

The current DDT rate = 28.325% (25% + 10% surcharge +3% education cess).

UPDATE: DDT after Budget 2015 = 28.840%

Post-DDT, the investor need not pay any more tax.

If a mutual offers periodic dividends and IF the NAV (post-dividend) falls to a constant base value, there is no capital gain associated with the original investment and  dividends that are reinvested (by the fund house on the same day dividend is declared).

That is, the capital gain in a dividend reinvestment option of a mutual fund offering periodic dividends is small if not zero.

Therefore, in such a scheme, the only tax involved is the DDT.

UPDATE: After budget 2014, the duration for short-term capital gains is 36 months for non-equity funds.  

Non-equity funds

Short-term Capital Gains (STCG): Had the investment been in a growth scheme and if the amount was redeemed within 3 years, the capital gain would be added to income and taxed as per slab.

For someone in the highest tax bracket, 30.9% tax is more than  28.840% DDT … technically speaking.

So if someone wants to hold a sum for less than 3 years, dividend reinvestment is a better option. Of course, one will have to check if there is any capital gain is incurred upon redemption.

Similarly, if such a person wants to do an STP to an equity over a few months (unnecessary), the dividend reinvestment option is simpler as it minimises (if not avoid) capital gains.

For more than 36 months holding period, capital gains now are are classified are ‘long-term’ and are taxed at a flat rate of 20.6% taking (cost inflation) indexation into account. This  is lower tax outgo than the 28.840% DDT. Hence for holding periods  more than 3 years, growth option is better irrespective of the tax-slab.

How indexation works:

Indexation means, I ask,

In the financial year of purchase the cost inflation index (CII) was 200 (say). Today, that is in the financial year of redemption the CII is 300 (say).  What is my purchase worth today?

This is given by (purchase price x 300)/200 = Indexed Purchase price

(same logic as elementary math: If five people eat 7 samosas, how many samosas will 13 people eat?!)

Here are some illustrations for different tax slabs:

The NAV is assumed to grow at a smooth rate.  The dividends are regular (monthly) and the NAV falls to Rs. 10 per unit after each dividend. The cost inflation index is assumed to grow at 8% each year.

The post-tax value for a lump sum investment of Rs. 10,000 is plotted wrt duration in months.

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10% tax slab: Growth option is always better (fixed deposits even better!!)



20% tax slab: Growth is always better (fixed deposits perhaps better for short durations!)



30% tax slab: Dividend reinvestment is marginally better if held for 36 months or less.




Equity-oriented funds (arbitrage funds)

In this case, the STCG Holding period  is less than 1 year (12 months  or less)

Only arbitrage funds in this category can offer reasonably regular dividends. However, the NAV need not fall to a constant base level. There could be, and usually is some growth. So there will be some capital gain.

Have a look at the NAV movement of HDFC Arbitrage fund. Source: Personalfn NAV history



For a few years, the NAV fell to Rs. 10 per unit after each dividend (the sharp fall). However, the dividends were never periodic. Recently the NAV has grown with only a couple of small dividends corresponding to a significant capital gain.

For holding periods less than a year, the short-term capital gains tax is 15.450% (15% + 3% cess).

However, there is no DDT!

This means that dividend reinvestment is better, irrespective of tax slab. Some short-term capital gains tax needs to paid, but it should not be as much as the growth option … if there are a few dividends during the holding periods.

For holding periods more than a year, long term capital gains are tax free.  Since there is no DDT as well, there is no difference between growth and dividend reinvestment options (apart from rounding off errors), but Growth is better because it is simpler.



For holding periods less than a year, dividend reinvestment is typically better than growth option. However, the difference is more than the case of non-equity funds. Assuming dividends are declared with reasonable regularity, dividend reinvestment funds are better in this case.


  • If you are unsure of when you will redeem, choose the growth and be done with it.
  • If the sum you are going to invest is not too huge, choose the growth and be done with it.
  • If you are planning a SIP, choose the growth and be done with it.
  • If you still do not understand the difference, choose growth
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  1. "If you are unsure of when you will redeem, choose the growth and be done with it" – For a equity fund i feel it is better to be in dividend option if you are pulling it within a year. As if u get a dividend it is fully tax free and even if there is a short term capital gain the taxation will be only on a small portion @ 15%. Same way if there is a short term capital loss after dividend payout it can be adjusted against any other short term capital gain.

  2. Dear Ganesh, I had only suggested an option not a solution, so during such discussions these suggestion can also be considered depending on one's requirement.

  3. Is it advisable to invest lumpsum in a balanced MF and start STP to a Diversified MF after one year (to avoid exit load)?
    How balanced funds worthable for retirement SWP?

    1. Investing a lump sum in a decent balanced fund like HDFC Balanced is more than enough. You do not need a STP to an equity fund. Reg. SWP for retirement, balanced funds are in general too risky. One will have to consider this on a case to case basis.

  4. Is it advisable to invest lumpsum in a balanced MF and start STP to a Diversified MF after one year (to avoid exit load)?
    How balanced funds worthable for retirement SWP?

  5. Srini,
    As you are aware, there are no hard and fast rules when it comes to these discussions. It is absolutely need based. It is like a bachelor scouting for a bride. He cannot get the best. He should know what he wants and go for that. The same is here with investing too. There is no best option. An investor should know what he wants out of an investment and choose accordingly. This is my humble opinion

  6. My suggestion will be to do a full equity investment and manage your debt depending on your taxation either in a bank FD or a FD in a good Nbfc OR in a mutual fund debt product depending on your risk profile (either FMP or short term debt). I feel a Balanced Fund is equivalent to a pure equity fund as mostly the allocation is 65% in equity and balance in debt. I feel the equity and debt component in a Balanced fund do not normally go in the same direction.

  7. Pattu, I had given it as an idea to all those (iam sure many will see it) if the amount had to be redeemed prematurely due to unavoidable circumstances.

  8. Hi

    Nice article.
    Can you throw some light on when to invest and redeem units from a Dividend mf considering below situation.
    1 buy and sell after Dividend declaration to minimise capital gains

    2 buy before div declaration and sell after div declared so loss or no profit will be incurred on paper.

    3 at random dates

    1. Why ‘invest’ in a dividend fund in the first place? It is not a wealth creation tool. Best to choose growth option.

      1. Yes although growth option is good I had once invested in DR mode and wanted to know what’s the best time for buy and sell units as per my original question.

        Thanks and regards,

        1. My understanding is for fund that declared dividends periodically (monthly) and regularly, if you buy before (after) a dividend, you must sell before (after) a dividend to minimise capital gains.

    1. Patti sir, how about comparing Real Estate vs direct or indirect equities? I’m really confused of this type of investment. I bought a land Rs.80k in 1985 now its 6cr. Does this happen if we go by direct or indirect equities option as advisor says yes it Compounds. Plz help.

      1. Growth in RE is not indexed like equity. So each investor will have different story. Difficult to compare.

        1. Thanks sir ji, How about just comparing direct vs indirect equities also future returns on both max time 30 years or holding for life?

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