A mutual fund is a professionally managed company that collects money from many investors and invests it in securities such as stocks, bonds and short-term debt, equity or bond funds and money market funds.
Mutual funds are a good investment for investors looking to diversify their portfolio. Instead of betting everything on one company or sector, a mutual fund invests in different stocks to try to minimize portfolio risk.
The term is typically used in the US, Canada and India, while similar structures around the world include the SICAV in Europe and the open-ended investment firm in the UK.
What is the difference between growth and dividend options?
Some investors enter mutual funds because they want to create long-term wealth. They start investing from the first part of their career. Then there are investors approaching retirement or have a body of retirement to invest that can supplement their other sources of income during the retirement phase of life. Mutual funds offer two options to meet these two conflicting investment needs.
A growth option reinvests the profits made by the fund into its underlying securities to drive future growth and the value of the fund. A growth plan has a higher NAV as stock profits are reinvested in the scheme and the power of composition comes into play.
A dividend plan distributes the profits realized by the fund in the form of dividend income from time to time at the discretion of the fund manager. Paying the dividend, although not guaranteed, can help supplement your income. In a dividend plan, the investor ends up with multiple units of the fund if he chooses a dividend reinvestment option, while he gets an additional source of income if he opts for a dividend payment option.
With effect from 1 April 2020, dividends became taxable in the hands of investors. Now investors will have to pay taxes on mutual funds’ dividend income according to their higher income tax bracket.
While you cannot ignore the additional tax burden in the case of the dividend option, the decision to choose one option over the other should be driven primarily by your financial goals/requirements.