When a fund registers gains over a period of time, it may choose to retain thee profits in the fund or it can decalre a dividend.

 

When the mutual fund declares a dividend and it is paid out to you, the fund's Net Asset Value stands reduced to that extent.

 

In this case, instead of receiving the dividend, the fund ploughs back the dividend declared into the scheme and you get an equivalent additional number of units allotted to you. The NAV will be lower to that extent.

 

In case of the growth option, whatever profits the funds generates, is retained with the fund, and is reflected by an appreciation in the funds NAV.

 

Example

 

Suppose you invested 1000 Rs @ NAV of 10 and you got 100 units. Assume that fund records an appreciation of Rs 2 per unit in its portfolio and declares this as dividend (2 per unit).

 

Dividend option - you will receive 2Rs * 100 units =200 Rs. NAV is Rs 10

 

Dividend Reinvestment- the 200 Rs will be invested at the prevailing ex dividend NAV i.e 10 and thus you will have 120 units (100 units original, 20 units as dividend).

 

Growth option - the 200 Rs will be reflected as NAV. Thus you will have 100 units but the NAV will be 12.

 

Which is then better.

 

If you are looking at a long term, that is creating a lumpsum after x years, Growth option is best.

 

If you are looking at regular payments (particularly after retirement), the dividend payout is best.

 

If you are looking to sell at some fixed regular intervals a part of the units, then dividend reinvestment is best.

 

Tax Angle:

 

Dividend out of "Equity" option funds are not taxed. This is true in case of dividend payout.

 

Returns earned out of appreciation and sale of units come under Capital gains tax. Less than 1 year are taxed as short term, more than 1 year hold period are taxed as Long term. Details of tax are available in another page titled capital gains tax