Dividend or Growth Option: Purpose, Suitability, Taxability (2024)

FAQs

How do you choose between dividend and growth options? ›

If you do not have any periodic liquidity needs, you may choose the growth option. The returns in the growth option will be reflected in the movement of the scheme's NAV. On the contrary, if you need regular cash flows from your investments, then choose the dividend option.

As an investor, whether you choose the growth or the dividend option will depend on your financial goals. When you choose the dividend option, you may lose out on the compounding returns as no reinvestment of dividends takes place and consequently, the process of goal achievement may be slowed down.

The NAV of growth option will always be higher than the dividend option because the profits re-invested in the growth option may grow in value over time. The total returns of growth option are usually higher than dividend option over sufficiently long investment horizon due to compounding effect.

Dividends from stocks or funds are taxable income, whether you receive them or reinvest them. Qualified dividends are taxed at lower capital gains rates; unqualified dividends as ordinary income. Putting dividend-paying stocks in tax-advantaged accounts can help you avoid or delay the taxes due.

Whereas dividend-paying companies are controlling expenditures, growth companies are spending on growth. A growth investment model is a strategy based on getting a return over a longer period of time, so it is generally best for someone with a longer time horizon who does not need as much liquidity.

Analysts should consider alternative methods, such as the multi-stage dividend discount model, residual income model, price-to-earnings ratio model, and discounted cash flow model, to provide a more accurate estimate of a company's terminal value.

Thus, the ones who want capital gain prefer the growth option. Note that it helps you reinvest your profits to maximise your returns. On the other hand, investors who prioritise income streams would prefer the Dividend Reinvestment Option. Notably, this one lets dividends compound with the help of additional units.

They are payouts of retained earnings, which is accumulated profit. Therefore, cash dividends reduce both the Retained Earnings and Cash account balances. There are three prerequisites to paying a cash dividend: a decision by the board of directors, sufficient cash, and sufficient retained earnings.

It is possible to switch from dividend option to growth option or vice-versa. It would entail sale of old units and purchase of new units. This might attract exit loads along with a tax on capital gains. Before you switch from one option to another, check for both of these aspects.

What is the main advantage of dividend growth model? ›

Advantages of Dividend Growth Model: It is simple, easier to understand and most widely used method to value equity. It values the stock by considering required rate of investor and not on the basis of Cost of Capital of a firm. Thus, it is relatively more Investor focused method.

There are times when it makes better sense to take the cash instead of reinvesting dividends. These include when you are at or close to retirement and you need the money; when the stock or fund isn't performing well; when you want to diversify your portfolio; and when reinvesting unbalances your portfolio.

Reinvested dividends may be treated in different ways, however. Qualified dividends get taxed as capital gains, while non-qualified dividends get taxed as ordinary income. You can avoid paying taxes on reinvested dividends in the year you earn them by holding dividend stocks in a tax-deferred retirement plan.

What Is a Good Dividend Yield? Yields from 2% to 6% are generally considered to be a good dividend yield, but there are plenty of factors to consider when deciding if a stock's yield makes it a good investment. Your own investment goals should also play a big role in deciding what a good dividend yield is for you.

You may be able to avoid all income taxes on dividends if your income is low enough to qualify for zero capital gains if you invest in a Roth retirement account or buy dividend stocks in a tax-advantaged education account.

Thus, the ones who want capital gain prefer the growth option. Note that it helps you reinvest your profits to maximise your returns. On the other hand, investors who prioritise income streams would prefer the Dividend Reinvestment Option. Notably, this one lets dividends compound with the help of additional units.

Look at dividend growth

Generally speaking, you want to find companies that not only pay steady dividends but also increase them at regular intervals—say, once per year over the past three, five, or even 10 years.

Different investor types tend to have a preference for how excess cash flow is returned. For example, investors who desire supplemental income, such as retirees, often prefer to receive dividends. A dividend is a real cash payment, which the investor can then use to spend however they wish.