Mutual Fund: Dividend Reinvestment or Growth?

A mutual fund dividend can be paid out to investors each quarter or each year, or the same money can be reinvested to purchase more shares of the underlying equity in the fund. If you would like to keep reinvesting earnings, the dividend reinvestment model is not the only option, though. There is also the growth option, which pays out no dividends at all. Instead, any cash that is earned is used by the mutual fund itself to invest into the total Net Asset Value of the fund. In both options, the investor does not receive regular payments. This is where the similarities stop.

Choosing a Growth Option

A growth option may seem like the riskier choice of the two. The investor does not get a say in how the earnings are reinvested; instead, the fund as a whole decides how the monies will be allocated. The investor wins only if the Net Asset Value of the fund increases to a higher level. Then, when the investor decides to sell shares, he or she will profit in capital gains in the long term.

Choosing a Dividend Reinvestment Option

A dividend reinvestment option is more straightforward for most investors to understand. The money earned on an investment is used to purchase more of the same. The investor will still receive dividend statements, making it easy to see the increase in the portfolio's value over time. There is a more tangible quality to this option, but it is not always favorable. The Net Asset Value of a fund is often more important than the total shares in the fund in terms of actual gains for each investor. Dividend reinvestment does not contribute to the Net Asset Value as the growth option does.

Tax Implications

In terms of taxes, the options are also treated differently. A dividend, even when it is reinvested, is technically paid to the investor. Each year, the investor will report the dividends and pay tax as part of the typical investment reporting. With a growth stock, the investor is actually contributing to capital, and the tax on that capital is deferred until it is sold for a profit. Only when the asset is sold will the investor pay taxes, and those will fall under the capital gains category. Therefore, depending on the investor's tax brackets, one option may have more tax advantages than another option.

Which Is Better? 

There is no single preferable option, which is why both options are available for investors to choose. If you would like to have a more tangible record of your gains, a dividend reinvestment may be the right choice for you. If you are more concerned with the long-term value of the fund, a growth option may be correct. You should also speak with an accountant to determine which will be more favorable for you in terms of tax liability. The best option is the one that will put the most money in your pocket. Therefore, the option that will cost you less in taxes will ultimately be the right one for you.

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