What are Growth Mutual Funds & How They Work?

When investing in equity funds, you have two options: growth or dividend funds. A growth mutual fund mainly invests in relatively younger but promising firms to achieve high capital appreciation over the long term.

This article will explain growth funds, how they work, their types, and their benefits in detail.

Growth mutual funds aim to achieve relatively higher capital appreciation than other funds by investing in growth-oriented assets like equities. These funds mainly focus on investments that exhibit remarkable growth potential and include stocks with little or no dividend payouts.

Growth funds are volatile in the short term because their value depends on the prices of the shares in which they are invested. However, in the long run, equity has outperformed most other investments in terms of returns.

As mentioned above, growth mutual funds invest in growth-oriented assets like equity shares. They aim to provide capital appreciation to the investor. You need to invest with a medium-term or long-term horizon.

Here is an illustration to help you understand the scenario:

Initial Investment:

You decide to invest in a growth mutual fund with a net asset value (NAV) of Rs. 20 per unit. Thus, you purchase 100 units of the fund, so your total investment is:

100 units × ₹20 per unit = ₹2,000

After 1 Year:

After a year, the value of the growth mutual fund increased, and the NAV rose to Rs. 30 per unit. The total value of your 100 units is now:

100 units × ₹30 per unit = ₹3,000

Capital Gain:

Your initial investment was Rs. 2,000, and the value after one year is Rs. 3,000. The difference between the selling price and the purchase price is your capital gain:

₹3,000 − ₹2,000 = ₹1,000

This ₹1,000 is your capital gain from the growth mutual fund investment.

Final Return On Investment(ROI):

Your capital gain or final value of an investment after one year would be ₹3,000 and ₹2000 is your initial investment. In this case, your return on investment (ROI) would be:

ROI  = [(Final investment value-initial investment value)/initial value] * 100

ROI = (3000-2000)/2000] * 100 = 50%

1. Long-term Capital Gains Tax

Long-term capital gains (LTCG) refer to the profit from selling shares or other assets held for over 12 months. In Budget 2024, the LTCG tax rate increased from 10% to 12.5%, while the exemption limit was raised to Rs. 1.25 lakh from the previous Rs. 1 lakh.

For example, John bought a house in 2005 for Rs. 20,00,000. He sold it in August 2024 for Rs. 65,00,000. The above example has not considered the indexation benefit as the sale was made after 23rd July 2024. The tax on said transfer will be applicable at the rate of 12.5%.

2. Short-term Capital Gains Tax

Short-term capital gains tax is applicable on the sale of equity shares and equity-oriented mutual funds held for less than 12 months. The applicable tax rate is 20% under Section 111A of the Income Tax Act.

For example, if Mr Rajesh purchased 1,000 shares of a company at ₹200 per share for a total of ₹2 lakhs and sold them within 8 months at ₹250 per share, the sale proceeds will be  ₹2.5 lakhs. Mr. Rajesh would incur a short-term capital gain of ₹50,000 in this case.

A GST rate of 18% is applicable for all financial services effective July 1, 2017. Thus, growth funds in India offer excellent returns against your investment in them. However, you must be ready to be patient with these funds and must possess a long-term investment plan. Also, you must be ready for any risk as such funds are highly volatile.

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