Advantages & Disadvantages Of Using Dividend Option
Choosing between the **Growth Option** and the **Dividend Option** in an Equity Linked Saving Scheme (ELSS) is an important investment decision because it directly influences how an investor receives returns from the fund. While both options invest in the same portfolio and provide the same tax-saving benefit under Section 80C, they differ significantly in the way profits are handled. Investors should therefore understand not only how these options work but also the advantages and disadvantages associated with each before making a decision.
The Dividend Option is designed for investors who prefer receiving periodic payouts instead of allowing all their returns to remain invested within the mutual fund. Whenever the Asset Management Company (AMC) declares a dividend, a portion of the distributable surplus is paid to investors holding units under the Dividend Option. These payments can provide additional cash flow, making this option attractive for investors who wish to receive money during the investment period rather than waiting until redemption.
One of the biggest advantages of the Dividend Option is that it provides **periodic income whenever dividends are declared**. Although dividends are not guaranteed, investors may receive payouts if the mutual fund generates sufficient distributable surplus and the AMC decides to distribute it. This can be useful for individuals who prefer receiving cash instead of allowing all returns to remain invested.
For example, a retired investor who wants supplementary income may appreciate receiving dividend payouts whenever they are declared. Instead of redeeming mutual fund units to meet regular expenses, the investor may use the dividend amount for household expenditures, medical costs, travel, or other financial needs. This provides flexibility while allowing the remaining investment to continue participating in market growth.
Another advantage of the Dividend Option is that investors gain complete control over how they use the distributed amount. Unlike the Growth Option, where profits remain invested automatically, dividend payouts become immediately available for spending or reinvestment according to the investor's preferences.
Some investors may choose to invest the received dividends into different financial products rather than reinvesting them into the same ELSS scheme. For instance, they may allocate the dividend toward debt mutual funds, fixed-income investments, emergency savings, or even other equity funds depending on their financial goals. This flexibility allows investors to diversify their portfolios according to changing financial circumstances.
The Dividend Option may also appeal to investors who prefer periodically realizing gains rather than watching their investment value fluctuate entirely with market movements. Receiving occasional payouts may provide psychological comfort to certain investors because they experience tangible returns without redeeming their investments.
Despite these advantages, the Dividend Option also has several important limitations that investors should understand before selecting it.
The most significant disadvantage is that **the investment loses the full benefit of compounding**. Compounding is one of the most powerful wealth creation tools available to long-term investors. Under the Growth Option, profits generated by the mutual fund remain invested and begin generating additional returns over time. This continuous reinvestment allows wealth to grow at an accelerating pace over long investment horizons.
Under the Dividend Option, however, a portion of these profits leaves the mutual fund whenever dividends are distributed. Since that money is no longer invested within the scheme, it cannot continue generating future returns. Consequently, the long-term growth potential of the investment becomes lower compared to the Growth Option, assuming both portfolios generate similar market performance.
To understand this difference, imagine two investors who each invest ₹1,00,000 in the same ELSS scheme. One chooses the Growth Option, while the other selects the Dividend Option. Over several years, the Growth investor allows every profit earned by the fund to remain invested, continuously benefiting from compounding. The Dividend investor, on the other hand, periodically receives payouts that reduce the amount remaining within the fund. Even if both investments begin with the same amount, the Growth Option generally accumulates greater wealth over time because every rupee remains invested and continues earning additional returns.
Another important aspect investors should understand is the effect of dividends on the **Net Asset Value (NAV)** of the mutual fund.
Many first-time investors mistakenly believe that dividend payments represent additional profits beyond the value of their investment. In reality, this is not the case. Whenever a dividend is distributed, the amount paid is deducted from the Net Asset Value of the scheme.
Suppose an ELSS fund has an NAV of ₹100 per unit before declaring a dividend of ₹5 per unit. After the dividend is distributed, the NAV may reduce to approximately ₹95 per unit, subject to normal market movements. Although the investor receives ₹5 in cash, the value of the investment decreases by nearly the same amount. Therefore, dividend payments do not create extra wealth; they simply distribute part of the value already accumulated within the mutual fund.
This explains why investors often observe that the NAV of the Dividend Option is generally lower than the NAV of the Growth Option over time. In the Growth Option, profits remain invested and continue increasing the NAV. In the Dividend Option, periodic distributions reduce the NAV whenever dividends are paid.
Another limitation is that **dividends are not guaranteed**. Some investors mistakenly assume that choosing the Dividend Option ensures regular income. However, the declaration of dividends depends on several factors, including the fund's distributable surplus, market conditions, regulatory requirements, and the decision of the Asset Management Company.
There may be periods when no dividend is declared at all, particularly if market conditions are unfavorable or if the fund manager determines that retaining profits within the scheme better serves investor interests. Investors should therefore avoid relying on dividend payments as a fixed or predictable source of income.
An additional point specific to ELSS investors is that **the Dividend Reinvestment Option is not available**. In earlier years, many mutual funds offered investors the choice of automatically reinvesting declared dividends into additional units of the same scheme. However, due to operational and regulatory considerations, the Association of Mutual Funds in India (AMFI) discontinued the Dividend Reinvestment Option for ELSS schemes. As a result, investors choosing the Dividend Option generally receive payouts rather than additional units.
When deciding between the Growth Option and the Dividend Option, investors should begin by evaluating their financial objectives rather than focusing solely on receiving periodic cash.
If the primary objective is **long-term wealth creation**, the Growth Option is generally the more appropriate choice. Since all profits remain invested, the portfolio benefits fully from compounding, which can significantly increase wealth over long investment horizons.
If, however, the investor prefers receiving cash distributions whenever dividends are declared and does not require maximum long-term capital appreciation, the Dividend Option may better suit those requirements. Investors who wish to use dividend payouts for living expenses or to invest elsewhere may appreciate the flexibility this option provides.
Age and financial circumstances also influence this decision. Younger investors who have many years before achieving their financial goals often benefit more from the Growth Option because they can maximize the effects of compounding. Individuals who require additional cash flow or have specific spending needs may find the Dividend Option more suitable, provided they understand its limitations.
Investors should also remember that the investment option itself does not determine the quality of the mutual fund. Regardless of whether one chooses Growth or Dividend, factors such as portfolio quality, consistency of returns, fund manager expertise, expense ratio, and long-term investment strategy remain equally important.
Ultimately, the Dividend Option offers flexibility and periodic cash distributions, making it suitable for investors with specific income requirements. However, these benefits come at the cost of reduced compounding potential and a lower Net Asset Value over time due to dividend payouts. The Growth Option, by contrast, allows the entire investment to remain invested, providing greater opportunities for long-term capital appreciation through continuous reinvestment of profits.
For most investors whose primary objective is building long-term wealth while benefiting from ELSS tax savings, the Growth Option generally proves to be the more efficient choice. Nevertheless, investors should always select the option that aligns with their financial goals, income requirements, and investment horizon. Making this decision thoughtfully ensures that the ELSS investment supports not only tax planning but also broader long-term financial success.