Systematic Investment Plans (SIPs)are gaining popularity among youthand motivating them to generate wealth through long-term investments in mutual funds, typically equity mutual funds. Traditionally, Indian investors were risk-averse and only preferred safer investments that offered guaranteed returns like bank fixed deposits (FDs) as they are not affected by market volatility. However, millennial investors have taken up the challenge to take calculated risks through SIP investmentsto counter market risks. This enhances the possibility of higher returns in the long run.
Investment through SIP comes with 2different options – Growth and Dividend Payout. When you invest in an SIP mutual fund with the Growth option, investors authorize the mutual fund house to reinvest the profits, thus increasing the net asset value (NAV) of your mutual fund. In the dividend distribution method, the fund manager or the fund house directly pays the dividends to the investors via electronic transfer or cheque.
It is natural to be confused about which investment to choose while starting with SIP investments and understanding how to invest in SIP. You can use a SIP Calculator to calculate the returns you would earn on your SIP investments and also tells you how much you would need to invest every month to earn a target corpus. Let’s understand.
What is a dividend distribution option?
Under this option, profits made by the mutual fund scheme are not reinvested in the scheme. The gains are instead distributed among the investors in the form of dividends. These gains might be distributed on a quarterly, half-yearly, or annual basis. However, the fund does not guarantee the dividend amount and the frequency of these payments. Usually, the fund manager distributes the dividends only when the mutual fund scheme generates profits. Dividends are paid to investors by redeeming equivalent units of the mutual fund scheme.
Let’s understand this with a simple* example:
Suppose you invest Rs20 in an equity mutual fund and its NAVincreases to Rs30, and the fund manager declares a dividend of Rs5. After the payment of the dividend, the NAV of the fund would now fall to Rs25.
What is the growth option?
The growth option is often perceived as a cumulative option. The profits made under this scheme are not paid by way of dividend. Instead, the gains are accumulated and further reinvested to purchase more units under the scheme. So the NAV of the scheme rises whenever it makes a profit. Similarly, the NAV falls whenever the scheme suffers a loss. The only way to get back profits would be to sell units of the scheme.
Let’s understand this with a simple* example:
Suppose you buy 10 units of an equity mutual fund at a NAV of Rs4. Under the growth option, the NAV rises to Rs5 in one year. You sell the units and receive a sum of Rs50. Hence, the net profit from your investment would be Rs10 (Rs50 – Rs40).
Which option is suitable for you?
Whether to go for growth option or dividend payout option solely depends on your financial needs. However, as a thumb rule, the dividend payout options tend to work best when the markets are at its peak. Growth option can be an ideal investment vehicle for individuals havingwith a long-term investment horizon as it helps them accumulate a corpus for their retirement or other long-term goals.
Happy Investing!
*Examples are for explanation purposes only!
