Growth stocks
These stocks are typically of high-growth companies whose earnings are growing faster than their peers or the overall market. Such companies prefer to retain excess cash and utilise it for business activities rather than dole out dividends to shareholders. They are usually still in their early or midgrowth stages and have substantial room to grow at a rapid pace and are usually among the outperformers during a market rally.
However, these growth stocks also carry with them a higher degree of risk. So, investors who want to buy such stocks should be able to stomach risk and volatility. Growth stocks become more lucrative when the markets are enjoying an upward rally. Investors in growth stocks believe that there are no meaningful rewards to be made from investing in safe blue chips. They seek 'alpha'-returns higher than the market-through stocks of growth oriented companies.
Dividend stocks
Dividend paying stocks, on the other hand, are usually associated with companies that have attained a certain size of operations and do not need large capital investments for further growth. These tend to have high cash flows, which they choose to return to shareholders in the form of dividends instead of ploughing back into the business.
Such companies grow at a steady pace and exhibit better resilience during an economic downturn. Investors in such stocks are exposed to very low downside risk and they prefer a steady stream of income, though the gains are modest.
Know the difference
A mutual fund generally offers two schemes: dividend and growth.The dividend option does not re-invest the profits made by the fund though its investments. Instead, it is given to the investor from time to time.In the growth scheme, all profits made by the fund are ploughed back into the scheme. This causes the NAV to rise over time.
The impact on the NAV
The NAV of the growth option will always be higher than that of the dividend option because money is going back into the scheme and not given to investors. In the above example of the HDFC Growth Fund, the NAV of the dividend option was 17.4150, while the NAV of the growth option was 25.2930.
How does this impact you?
- You don't gain or lose per se by selecting any one scheme.
- Either you make the choice to get the money regularly (dividend) or at one go (growth).
- If you choose the growth option, you can make money by selling the units at a high NAV at a later date.
- If you choose the dividend option, you will get the money time and again as well as avail of a higher NAV (though the NAV here is not as high as that of a growth option).
- Say there is a fund with an NAV of Rs 18. It declares a dividend of 20%. This means it will pay 20% of the face value.
- The face value of a mutual fund unit is 10 (its NAV in this case is 18).
- So it will give you Rs 2 per unit. If you own 1,000 units of the fund, you will get Rs 2,000.
- Since it has paid Rs 2 per unit, the NAV will fall from Rs 18 to Rs 16.
- If you invest in the growth option, you can sell the units for Rs 18.
- If you invest in the dividend option, you can sell the units for Rs 16, since you already made a profit of Rs 2 per unit earlier.
What you must know about dividends
The dividend is not guaranteed.If a fund declared dividends twice last year, it does not mean it will do so again this year. You could get a dividend just once or you might not even get it this year.Generally, funds whose NAV is above 10 are in a position to consider a dividend. Remember, though, declaring a dividend is solely at the fund's discretion; the periodicity is not certain nor is the amount fixed.
Which should you take?
This depends on your overall investments and income.If you are looking at a long-term investment and are not interested in money being given to you at various intervals, the growth option is meant for you.If you are keen on receiving an income at various intervals, opt for the dividend option.
The tax impact
Dividends from a mutual fund are not taxed.Now for a look at the tax impact when you sell the units.When you sell the units of a mutual fund and make a profit, it is known as capital gain.
Equity and equity related funds
These would entail two types of funds:
- An equity fund (invests in shares)
- A balanced fund (invests in shares and fixed income instruments) that has more than 50% of its investments in shares.
If you sell the units of such funds within a year of your purchase, the profit on this sale is called a short-term capital gain. You will be taxed 10% on short-term capital gain.If you make a make a profit by selling the units after a year, it is called long-term capital gain. This is not taxed.
Beofre you take a call on which investment option you want, do take into account the tax impact and your income requirements.
