IDCW Mutual Fund: All You Need To Know

IDCW Mutual Fund

Investing in mutual funds can be a bit confusing for people. Investors who opt to invest in mutual funds can choose between two payout options, growth or dividend. However, the dividend option is not available anymore. Instead, you have the IDCW option in mutual funds. IDCW refers to Income Distribution cum Capital Withdrawal.

In the dividends option, an investor would receive dividends on the earnings from a mutual fund scheme. The proceeds generated could then be reinvested or distributed among investors. However, based on the recommendations of the Mutual Funds Advisory Committee (MFAC), the Securities and Exchange Board of India (SEBI) has renamed the dividend option as Income Distribution cum Capital Withdrawal (IDCW). In this article, we will talk about IDCW in mutual funds and why you should opt for this payout option. 

What Is A Growth Plan?

Mutual fund schemes profit from dividends on stocks and interest on debt investments, as well as gains on the sale of these investments. In both growth and IDCW scenarios, the underlying portfolio remains the same.

However, in the growth plan, the profit from the fund is reinvested, boosting the monetary gain from compounding and increasing the net asset value (NAV). Except when you sell your investments in the fund, you do not get any payment from the scheme.

What is IDCW In Mutual Funds?

This option declares ‘dividends’ from the mutual fund’s gains on a regular basis. The frequency of dividend payments might be daily, monthly, quarterly, or annual.  

A dividend is declared in a mutual fund. This dividend, however, is not a portion of the fund’s profits that it is passing on to the investor. Instead, a mutual fund dividend is a share of your capital that the fund withdraws and distributes to you. As a result, the value of your investment decreases. Thus, the dividend option is funded by your gains, which generally translates to generating profits on investments on a regular basis.

SEBI And Its Role In IDCW

SEBI renamed the term ‘dividend’ in April 2021. What was once known as a ‘dividend’ is now known as ‘distribution’. The ‘Dividend Plan’ of a mutual fund is now known as the ‘Income Distribution cum Capital Withdrawal Plan’, or the IDCW Plan. 

The purpose behind the renaming was to use the correct terminology and notify investors that mutual funds do not pay ‘dividends’.

Basically, SEBI renamed the ‘Dividend Plan’ to IDCW in mutual funds because many investors mistook the term to mean that these mutual fund are investing only in those companies which generate dividends. An investor’s investment strategy could be adversely affected as a result of this false understanding.

Investors receive dividends in case of IDCW plan from the mutual fund which is actually the return generated by the mutual fund through (a) capital gains from increase in value of its investment and (b) dividend from stocks in its portfolio, in case of an IDCW plan the dividend is transferred to the investors periodically. The NAV of the investor’s investment decreases at the same time as the investor receives dividends. Realistically, the return is not dividend but capital withdrawal.. It’s the same as withdrawing funds from a bank account. Since the gain was always known as ‘distribution’, SEBI changed the name to reflect this fact. In mutual funds, the term ‘IDCW’ has the same meaning as ‘distribution’. 

When it concerns mutual funds, investors may sometimes find it difficult to understand the distinction between income and capital distributions. Realised profits are put into a separate account known as the equalisation reserve account when a unit is sold for more than its face value. This account pays dividends. In order to better clarify these distinctions, SEBI has renamed its dividend plan as Income Distribution cum Capital Withdrawal (IDCW).  

Misconceptions about mutual fund dividends in India

There are various misconceptions regarding mutual fund dividends among investors in the country. Let’s debunk some of these misconceptions. 

Misconception 1: There are underlying stocks in a mutual fund portfolio that pay dividends to investors.

Reality: As part of a fund’s dividend payout, the company may include dividends received from its underlying holdings, such as stock in the fund. In addition, it may contain the gains realised through the sale of the portfolio’s holdings.

Misconception 2: Dividend payments from mutual funds provide investors with additional income on top of profits.

Reality: Mutual fund dividends are not an additional source of income for investors, but a supplement to the returns they receive when they redeem their investments. Instead of capital appreciation, which is paid from the investor’s capital, dividends from mutual funds are distributed. To the degree that shareholders have received dividends, the dividend scheme’s NAV decreases.

Misconception 3: Dividend options in the schemes of mutual funds constantly record gains to distribute dividends to shareholders.

Reality: Any option, such as growth or dividend, has the same underlying mutual fund portfolio. Because of this, every alternative is considered when the fund management records a profit — whether it’s for growth, dividends, or something else entirely. There is a significant distinction in the way earnings are distributed:

• In the growth option, all profits are reinvested in the scheme, and this is reflected in the NAV.

• In the dividend option (now referred to as IDCW), the fund manager or asset management company (AMC) can choose whether or not to deliver a portion of the earnings to investors. However, investors should keep in mind that the AMC is not required to pay dividends under the mutual fund scheme profit distribution option.

A few other such misconceptions are as follows:

• Dividend declaration by a mutual fund scheme is an indicator of the fund’s performance.
• Dividends earned can be a regular source of income.

However, none of these are true. 

How Does Dividend Distribution Work In Mutual Funds?

Here is an example to illustrate how dividend distribution works in IDCW in mutual funds:

• A unitholder in a dividend or an IDCW mutual fund scheme owns 5,000 units, and the fund’s NAV is INR 10. Dividends are included in the NAV. As a result, the unit bearer’s overall investment value is INR 50,000.

• For example, let’s imagine a mutual fund pays out a dividend worth INR 5. A dividend or IDCW of INR 5,000 (INR 5 x 5000 units) is therefore due to the unit holder. The investor’s capital account or equalisation with the fund will be credited with this amount.

• The NAV excluding dividends is INR 10 if the unitholder redeems this amount. That’s INR 50,000 invested in total (INR 10 x 5000 units).

• There would have been no dividends if the investor had chosen the growth option scheme instead of IDCW, which would have kept the investor’s investment consistent.

Taxes on an investor’s income from the IDCW mutual funds are calculated based on the investor’s tax bracket. As a result, investors who receive more than INR 5,000 in dividends will be liable to pay TDS.

Difference Between The Two Options

Growth and IDCW are the two options available to the investor while investing in mutual funds. 

• Growth In Mutual Funds

The mutual fund provider can reinvest the money that would otherwise be paid out as a dividend if the investor chooses the growth option. The mutual fund’s net asset value increases as a result of this investment.

For investors who want to obtain regular cash distributions from their assets, the growth option is not a smart choice. This is because the fund house spent all of the dividends that would have been paid out to invest in more companies and increase the capital of its investors. In this case, the investor does not receive extra shares, but the value of their fund shares rises.

• IDCW In Mutual Funds

This means reinvesting your dividend. This alternative is extremely unique. Rather than paying out dividends to fund investors, the dividends are used to buy new fund shares. The investor does not receive cash when the fund’s stock dividends are paid out. Capital gains are realised when fund units are sold, and dividend reinvestment options typically result in more fund units being sold than originally purchased. In the case of a dividend reinvestment option, investors may wind up with more fund units than they started with when they sell their shares.

Example of a mutual fund scheme dividend payout

Let’s say a person has 1,000 shares in a mutual fund. The scheme’s current NAV (cumulative dividend) is INR 100. What would happen to his/her investment if the scheme paid out a dividend of INR 5 per unit?

The dividend paid to the investor was not a bonus. The value of the investment would have been INR 100,000 if the investor had invested in the growth plan. This is because, with the growth option, dividends are not paid.

Why invest in IDCW mutual funds

• Investors seeking a steady stream of returns on their capital can consider IDCW mutual funds. The IDCW generated by these mutual funds is also negligible, but it must be taken into consideration.

• Retired investors expect consistent cash flows; therefore, they can choose IDCW knowing the income distribution is at the fund manager’s discretion.

• It also depends on the performance of the underlying firms and market fluctuations, and IDCW distributions in mutual funds are not guaranteed.

• Low-risk investors can pick IDCW mutual funds for reliable returns. They can also pay dividends during a bad market.

• IDCW income is included in the investor’s taxable income and taxed at the investor’s regular slab rate. Dividends from IDCW that exceed INR 5,000 are taxed.

Conclusion

Investors must consider their risk tolerance, investment objective, and aims before choosing a dividend or growth alternative.

The IDCW option in mutual funds works best when markets are high. For long term growth, choose the growth plan. The growth option is best for long-term wealth creation.  Profit payment distinguishes IDCW from the growth option. Investors must invest in a growth or an IDCW mutual fund plan that generates big returns and boosts portfolio performance.

What are you waiting for? Start investing with Kuvera that helps you to set financial goals and invest in various financial schemes. Explore mutual fund plans, fixed deposit schemes, and other investment avenues with Kuvera and start investing. 

FAQs

• Which is better, growth or IDCW plan in mutual funds?

The Growth Plan is more tax-efficient than Dividend or IDCW Reinvestment. Investment priorities, investor’s risk, and tax impact should determine your choice.

• What is the IDCW plan in mutual funds?

IDCW signifies Income Distribution cum Capital Withdrawal, which is a Dividend plan. Mutual fund dividends are a partial payout of the earnings made from the underlying investments.

• What is the monthly IDCW payout?

The AMC sets the dividend per unit (IDCW). Whether a scheme pays dividends or not, accrued earnings belong to investors and are reflected in the fund’s NAV (Net Asset Value).

• What do I need to know before investing in mutual funds?

You must research well before choosing and investing in any mutual fund scheme. Kuvera can help you understand your risk capability, financial goals, and tax liability.

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