Which option is better on a mutual fund: a growth option or a dividend reinvestment option?

By Investopedia Staff AAA
A:

When selecting a mutual fund, an investor has to make an almost endless number of choices. Among the more confusing decisions to be made is the choice between a fund with a growth option and a fund with a dividend reinvestment option. Each type of fund has its advantages and disadvantages, and deciding which is a better fit will depend on your individual needs and circumstances as an investor.

The growth option on a mutual fund means that an investor in the fund will not receive any dividends that may be paid out by the stocks in the mutual fund. Some shares pay regular dividends, but by selecting a growth option, the mutual fund holder is allowing the fund company to reinvest the money it would otherwise pay out to the investor in the form of a dividend. This money increases the net asset value (NAV) of the mutual fund. The growth option is not a good one for the investor who wishes to receive regular cash payouts from his/her investments. However, it's a way for the investor to maximize the fund's NAV and, upon sale of the mutual funds, realize a higher capital gain on the same number of shares he/she originally purchased - because all the dividends that would have been paid out have been used by the fund company to invest in more stocks and grow clients' money. In this case, the fundholder does not receive more shares, but his/her shares of the fund increase in value.

The dividend reinvestment option is quite different. Dividends that would otherwise be paid out to investors in the fund are used to purchase more shares in the fund. Again, cash is not paid out to the investor when dividends are paid on the stocks that comprise the fund. Instead, cash is automatically used by the fund's administrators to buy more fund units on behalf of the investors and transfer them to individual investors' accounts. Fundholders realize a capital gain upon the sale of their units in the fund, which in the case of the dividend reinvestment option will probably be more fund units than they started with.

No single mutual fund is perfect for every investor; that's why there are so many out there with so many different options. When investing in a mutual fund, it's best to examine all of the particulars of the fund, to avoid investing in a fund that doesn't suit your individual requirements for growth or cash payout.

RELATED FAQS

  1. What is the difference between a REIT and a real estate fund?

    A real estate fund invests in securities offered by public real estate properties directly or indirectly through Real Estate ...
  2. What is a volatility smile?

    Discover what options traders mean when they refer to a "volatility smile," and learn why a volatility smile's existence ...
  3. How do I calculate the dividend payout ratio from an income statement?

    Understand the dividend payout ratio, how it differs from the dividend yield and how it can be calculated from a company's ...
  4. What are the pros and cons of owning preferred stock instead of common stock?

    Understand and explore the advantages and disadvantages of owning preferred stock as opposed to owning common stock shares ...
RELATED TERMS
  1. Policyholder Dividend Ratio

    The policyholder dividend ratio is a measurement of the profitability ...
  2. Paid-Up Additional Insurance

    Additional whole life insurance that a policyholder purchases ...
  3. Accelerated Dividend

    Special dividends paid by a company ahead of an imminent change ...
  4. Historic Pricing

    A method for calculating the value of an asset using the last ...
  5. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  6. Multibank Holding Company

    A company that owns or controls two or more banks. Mutlibank ...

You May Also Like

Related Articles
  1. Options & Futures

    Options -- Accessing Stakes In Apple ...

  2. Trading Strategies

    Risk Management Techniques For Shorting ...

  3. Mutual Funds & ETFs

    Why Monthly Dividend ETFs are Good for ...

  4. Options & Futures

    These Are The Top Brokerage Firms For ...

  5. Trading Strategies

    General Electric: Good News/Bad News

Trading Center