Mutual Fund: Growth Versus Dividend Option

Hi,
I am an independent Financial Advisor based in Mumbai. I have one query. In any MF scheme, there are two options we have. One is Dividend and the other is Growth. The specific scheme has a fixed portfolio in which it has invested the AUM.  now my queries are -
1. How can you have two different values (NAV's of dividend and growth) for the same basket of stocks?
2. If dividend is declared and paid out, isn't it at the cost of the "growth option" holders?
I have not clearly understood how nav is calculated for growth and dividend. Pls forgive my ignorance. If you can spare the time please reply at your own convenience.
Regards.

Well, your query is very true. In fact, many people have confusion about the difference between the 2 options – Growth & Dividend.

Let us understand this by example.

Let us assume that you invest Rs.1,00,000 in NFO at NAV of Rs.10 per Unit. You invest Rs.1,00,000 in each of the 2 options – I mean 1 Lakh in Growth option and 1 Lakh in the Dividend Option of the same scheme. So You will be allotted 10,000 Units for both of your Investments right?

Now, we will consider Your Growth Option Investment as Investment G and the Dividend option Investment as Investment D….OK?

Now, What happens if your the mutual fund gives 20% return at the end of year? Well, In that case the NAV of both the G & D Investments will be Rs.12 per unit right? So Your 1 Lakh Invested in both the options will become Rs.1,20,000…. Right?

Thus, you have a capital gain of Rs.20,000 for each of your Investment. Now, the Fund house decide to give you Rs.10,000 as a Dividend pay out. This means that, your fund house declares Rs.1 per Unit of Dividend. So your Investment D NAV will fall by 1 rupee to Rs.11. So you will get Rs.10,000 as a bonus and thus your Investment D Value will become Rs.1,10,000.

Investment G has not declared anything so it’s NAV will remain Rs.12 per unit and the value will be Rs.1,20,000.

So Now, Your Investment G is Rs.1,20,000 (NAV Rs.12 per Unit) and our Investment D is Rs.1,10,000 (NAV Rs.11 per unit).

Here comes your next query. Well, see. The Dividend is not declared at the cost of Growth portfolio investment. The Dividend is declared by selling Rs.10,000 amount of security from the portfolio of Dividend Investors. Both the Dividend & Growth Portfolios are maintained separately. Their composition is the mirror image of each other.

And still the composition of both the Growth and Dividend portfolios will remain exactly the same. Means both will have Reliance shares of 9%, TCS shares of 4% and so on. Your Fund house will take care of everything.

Ok now, the next year if the portfolio of this mutual fund will give you 10% return than the NAV of Investment G will be Rs.13.2 (10% of the previous NAV. So Rs.12+1.2 = 13.2) and the NAV of Investment D will be Rs.12.1 (10% of the previous NAV. So Rs.11+1.1 = 12.1).

So Now, the value of your Investment G will be Rs. 1,32,000 (10,000 Units multiplied by Rs.13.2) and the value of your Investment D will be Rs. 1,21,000 (10,000 Units multiplied by Rs.12.1).

Now, again the Dividend Option decides to give you Rs.1.1 per unit dividend. So the NAV of Investment D will fall to Rs.11 and the Dividend payout will be Rs.11,000 (10,000 Units multiplied by Rs.1.1). And your Investment D worth will be Rs.1,10,000. (10,000 Units multiplied by Rs.11).

So Now the NAV of Investment G is Rs.13.2 per Unit and the NAV of Investment D is Rs.11 per Unit.

So every year, this goes like this. Remember, it is the fund’s decision that how much to give as a dividend pay outs. As long as the NAV is above 10, it can deliver your the dividend payouts.

Here I am mentioning you 2 useful Resources -

01) ValueResearchonline: Growth Vs Div Re-Investment – See the only difference between growth and Dividend options is Tax.

02) ValueResearchonline: Growth Vs Div Re-Investment – Read the basics of Growth & Dividend Re-Investment Option