Investors can invest in a mutual fund scheme with a growth or dividend component. Additionally, those who choose the dividend option will receive dividends for the gains made by the underlying mutual fund scheme.
Mutual fund dividend schemes received a fresh iteration. This is due to a circular issued by the regulator SEBI instructing fund houses to stop using the term “dividend” and start using “income distribution cumulative withdrawal” (IDCW) as of April 2021.
What is IDCW?
Income Distribution Cumulative Withdrawal, or IDCW, describes income distribution from a mutual fund scheme. This income may comprise stock dividends, and capital gains realised from selling underlying equities from the scheme’s portfolio. SEBI also stressed that this revenue is solely derived from the investor’s investment value. In other terms, it equates to a capital withdrawal.
Investors in IDCW mutual funds can choose dividend distribution or dividend reinvestment. The AMC will transfer the dividend amount to the investor’s bank within 15 days of the dividend declaration date if they decide on the dividend payout option.
Benefits of IDCW
- The fund manager / AMC can transfer all or a portion of the scheme’s profits to the investor in IDCW. Compounding is lost in the IDCW option since investors get IDCW payouts periodically.
- In the growth option, the scheme’s earnings are reinvested in the strategy. Investors can profit from other investors’ earnings if they invest for a long time. This, often known as the power of compounding, can significantly contribute to an investor’s ability to create wealth.
- Investors should invest in the mutual fund scheme’s growth option if their investing goal is capital growth or long-term wealth creation.
Disadvantages of IDCW
The fund’s NAV decreases each time earnings are distributed. As the payouts are added to the income and taxed following the income tax bracket, those in the higher tax bracket will have to pay more taxes. This may reduce an investor’s overall return from investing in an IDCW fund.
How does IDCW in mutual funds work?
Let’s understand how IDCW work with the following example:
An investor owns 10,000 units of a IDCW mutual fund scheme, and the fund’s NAV is Rs 10. Dividends are included in this NAV. As a result, the unit holder’s total investment is worth Rs 1,00,000. Suppose a mutual fund announces a payout of Rs 5. A dividend or IDCW of Rs 50,000 (Rs 5 * 10,000 units) is, therefore, due to the investor.
The investor’s bank statement or equalisation reserve with the fund will receive credit for this sum. The NAV excluding dividends is Rs 5 (10-5) if the unit holder redeems this sum. The overall investment is, therefore, Rs 50,000 (Rs 5*10,000 units).
There would not have been a dividend distribution, and the investor’s capital would have stayed unaffected if they had invested in a growth option scheme.
A feasible alternative to traditional products like fixed deposits or savings schemes might be investing in IDCW mutual fund investment schemes. It is also appropriate for investors if they want a steady return on their investment. Keep in mind that mutual fund returns cannot be guaranteed.