How Mutual Funds Make Money for Investors

Mutual funds earn returns from the performance of underlying investments. When the value of these holdings rises, the fund’s NAV increases. If you redeem at a higher NAV than your purchase price, you realise a gain.

Example: Invest ₹1,00,000. NAV grows 15% over two years. Your investment is now worth ₹1,15,000. The ₹15,000 gain is capital appreciation.

Income / Dividend Distribution

Some mutual funds hold dividend paying stocks or interest bearing bonds. When those assets generate income (dividends from stocks, interest from bonds), the fund can distribute that income to investors.

In India, SEBI allows funds to offer a “dividend option” where periodic payouts are made to investors. Dividends are paid out of the fund’s NAV.

When you invest, you choose between Growth and Dividend options.

Growth Option:

All income stays in the fund and compounds. NAV keeps rising. You only realize gains when you sell. Better for long-term wealth building.

Dividend Option:

Income is paid out periodically. NAV drops by the dividend amount. You get cash in hand, but your investment value doesn't grow as fast as growth option.

Tax difference considerations:

At the time of writing this article, in India, dividends from mutual funds are added to your total income and taxed at your applicable slab rate. Capital gains have different tax treatment depending on category and investment tenure.

For wealth creation, growth options make more sense for most investors. Dividend option suits those needing regular cash flow.