What is a growth option in mutual funds?

A growth option in mutual funds refers to a specific investment facility designed to maximise the potential for capital appreciation over the long term. Growth Options are offered by mutual fund companies, alongside other variants like Reinvestment of Income Distribution cum Capital Withdrawal (IDCW) option or Payout of IDCW option. Let’s check out what is the growth option in mutual funds in detail and take a look at the Growth option definition.

• Table of contents

• Understanding growth options
• Things to consider before investing in growth option
• Features of growth option
• Differences between growth vs IDCW reinvestment options
• Which is better? - growth vs IDCW reinvestment option
• Taxation on growth vs IDCW reinvestment option
• Are there investments where I can get both growth and dividends?

Understanding growth options

The distinguishing feature of a growth option mutual fund scheme lies in its facility to retain gains in the scheme. Unlike the IDCW payout option, where IDCW earned on investments are distributed to investors periodically, a growth option retains all gains in the fund. Over a period of time, the NAV of the growth option will be higher than IDCW options since the gains are retained in the Plan.

Investors opting for a growth option in mutual funds typically have a long-term investment horizon and are willing to withstand market fluctuations in pursuit of potentially higher capital appreciation. This aligns with the inherent nature of equity investments, which tend to exhibit relatively higher volatility in the short term but have historically delivered a superior return potential over extended periods.

Things to consider before investing in growth option:

Before opting for the growth option in investments, it's crucial to consider several factors to align with your financial goals and risk tolerance. These considerations ensure that the chosen investment strategy optimizes potential returns while managing associated risks effectively.

• No regular income: Growth options offer no regular IDCW and may not suit investors seeking a steady income stream.
• Tax implications: Capital gains realised upon selling units in a Growth Option equity mutual fund are subject to taxation.

Also Read: Should Young Investors opt for the IDCW Payout Option in Mutual Funds?

Features of growth option

The growth option in mutual funds reinvests profits back into the fund, allowing for potential capital appreciation. Key features include:

1. Potential for capital appreciation: Profits are reinvested, increasing your investment base.
2. Compounding effect: Reinvested gains generate further returns over time.
3. No regular payouts: Investors do not receive periodic dividends; earnings remain invested for growth.
4. Geared toward long-term investors: This option is more suitable for those who seek to potentially build wealth in the long-term instead of seeking immediate income.
5. Tax efficiency: Investors are taxed only when redeeming units, avoiding yearly dividend taxation.

Differences between growth vs IDCW reinvestment options

Both growth and IDCW reinvestment put profits back into the fund, but their mechanism is different

Growth option:

• Profits are automatically reinvested, increasing NAV.
• No regular payouts, focusing on long-term appreciation.
• Tax applies on capital gains only upon redemption.

IDCW (formerly dividend reinvestment) option:

• IDCW payouts are used to purchase additional units.
• NAV drops by the dividend amount, and new units are allocated.
• Both IDCW income and capital gains are taxable.
• IDCW income is added to an investor’s income and taxed per their slab.

Growth vs IDCW reinvestment option – which is more suitable?

The choice depends on financial goals and tax considerations:

Growth option:

• Suitable for investors focusing on long-term wealth accumulation.
• More tax-efficient, as gains are taxed only upon redemption.
• Avoids immediate taxation on IDCW income.

Dividend reinvestment option:

• Allows reinvestment and therefore increases number of units owned
• Less tax-efficient due to dividend taxation.

Taxation on growth vs IDCW reinvestment option

• Growth option: Profits are reinvested, increasing the Net Asset Value (NAV). Tax applies only upon redemption.
• IDCW reinvestment option: IDCW income is declared and used to buy additional fund units. Dividends are added to the investor’s income and taxed according to the applicable slab rate.

Are there investments where I can get growth and dividends?

Mutual funds do not offer dividend income. They offer IDCW payouts if opted for. Therefore, in mutual funds, you can either choose IDCW or Growth – you cannot usually combine the two. However, some stocks offer the potential for regular dividends along long-term growth potential.

Also Read: How IDCW payouts affect NAV in mutual funds

Conclusion

In conclusion, a growth option in the mutual fund is a strategy that involves retaining gains instead of making a payout to the investors. This strategy aims to maximise the potential for capital appreciation over the long term by harnessing the power of compounding. However, investors should carefully assess their risk tolerance and investment objectives before opting for a Growth Option of any scheme, ensuring it aligns with their financial goals and time horizon.

FAQs

What is a growth option in mutual funds?

In a growth option, the fund’s profits are reinvested instead of being distributed as dividends. This leads to an increase in the Net Asset Value (NAV), allowing investors to benefit from potential capital appreciation when they redeem their units.

Who should invest in a growth option?

The growth option is suitable for investors focused on long-term capital appreciation. It is suitable for those who do not require the potential for regular income and prefer to let their investment potentially compound over time.

Should I stop reinvesting IDCW payouts?

The decision depends on financial goals. If potential for income from your investments is needed, the dividend payout option may be more suitable. For those prioritizing potential long-term growth, reinvesting IDCW income or choosing the growth option can enhance the potential for wealth accumulation.

Does reinvesting IDCW income avoid tax?

Reinvesting dividends does not provide any tax exemption. While the reinvested amount increases the number of units held, IDCW income is taxed based on the investor’s income tax slab. Reinvestment simply means the IDCW income are used to purchase additional units.

What is the point of reinvesting dividends?

Reinvesting dividends in the case of stocks or IDCW income in the case of mutual funds enhances the potential for compounding, as the income can be used to purchase additional fund units or shares. This increases the overall investment base and enhances potential future returns.

What happens to my gains in a growth option mutual fund?

In a growth option, gains remain invested in the fund, leading to an increase in the Net Asset Value (NAV). As the fund’s value rises, the investment grows, and potential gains are realized when units are redeemed (depending on market conditions and the prevailing NAV at the time of redemption.

Is a growth option better than IDCW option?

The choice depends on investment goals. A growth option automatically reinvests gains, enhancing the potential of long-term compounding. IDCW reinvestment increases the number of units held in the mutual fund but also attracts taxation.

What are the benefits of investing in a growth option?

Key benefits include enhanced growth potential, and simplicity, as there is no need to track or reinvest IDCW income manually. Moreover, it is more tax efficient than IDCW.

Which mutual fund categories commonly offer growth options?

Most mutual fund categories, including equity, debt, and hybrid funds, provide a growth option. It is a standard feature across different fund types, catering to various investment preferences.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.