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IDCW Mutual Fund in 2022: IDCW Scheme Meaning, Definition & Details

Want to know how IDCW in mutual funds works? Know all about IDCW in mutual fund plans, how it works & where should you invest your money.

The IDCW full form in mutual funds is Income Distribution cum Capital Withdrawal. Knowing the IDCW meaning in mutual funds is imperative for investors. It refers to the distribution of the income generated by a mutual fund scheme, which may include the dividends paid by stocks and the capital gains generated by selling underlying stocks from the scheme portfolio.

IDCW has become the buzz term amongst all mutual funds investors. But what is IDCW in mutual funds? It is the new name of an earlier option in mutual funds known as the Dividend Option.  

The term IDCW mutual fund came into being because the SEBI agreed that the term “Dividend” was misleading in the context of mutual funds. In its actual meaning, Dividend refers to the income generated over the amount that the investor is investing. But in the mutual fund schemes, the dividend option was merely a name given to the activity of giving out a certain amount of money back to you from the initial investment that you had made. 

Hence, the term “Dividend” was misleading, and therefore, the SEBI changed it to IDCW. 

What are dividend plans in mutual funds?

Every mutual fund's plan has two broad options: a growth plan and a dividend plan. The dividend plan in a mutual fund or the IDCW in mutual funds is mainly focused on providing regular payouts to investors. It distributes whatever profits the scheme makes amongst all the investors. But the dividend plans payout only if the fund makes a profit or if its value in the market increases. Also, with every dividend paid out, the net asset value or NAV of the fund goes down. The dividend plan in a mutual fund is good for generating a steady income but not if you want your investment to grow, i.e., multiply itself.

Misconceptions about IDCW

Even today, most novice investors have a dividend fund in their portfolios. But certain misconceptions still prevail while investors discuss dividend plans in mutual funds.

  1. The underlying stocks pay the dividend: While it is true that underlying stocks pay a certain portion of the dividend, it may also include the dividends received by the scheme from the underlying stocks in the scheme portfolio or gains received by selling the underlying stocks held by the scheme portfolio.
  1. Dividends are extra income over the capital: Dividend plans in mutual funds are not extra profit over your capital. Dividend plans payout from the surplus of the investment made in the fund. As such, dividend plans essentially return a part of the money, you invested in the scheme, back to you.
  1. Dividends payout regularly. The dividend option or IDCW in mutual funds does not regularly book its profit to pay dividends. This means that dividend options in mutual funds are not liable to pay the investors regularly. They pay only when a surplus of investment occurs.

Difference between dividends declared by mutual funds and companies

There are two types of dividends in the investing world. Dividends on stocks or shares, and the dividend option in mutual funds, now known as the IDCW in mutual funds. What exactly are the differences between the two? Let us have a look.

Companies pay dividends to their shareholders regularly after  a certain period of time. This payment of dividends comes from the extra revenue that the company generates. In essence, the company's dividends are paid from the profit after tax or PAT. Companies generate revenue, then decide how much they need to reserve for the company’s future growth. The remainder is distributed as dividends amongst the shareholders. The NAV of the shares of a company is generally not affected by the dividend paid by the company.

On the other hand, mutual funds schemes pay their dividends from the generated surplus investment, also known as the accumulated profit. The major difference is that the NAV of the investment is reduced after every dividend is paid out. The mutual fund scheme is also not responsible for paying out dividends regularly.

How does dividend distribution work in mutual funds?

Dividend distribution is based on the number of shares that a shareholder or an investor holds in a mutual fund. Based on these shares, the total dividend to be paid to a shareholder is decided. The table below gives an overview of how a total dividend of Rs. 50,000 would be distributed amongst five shareholders that hold 100 shares together.

NameDavidEzekielAmarShreyaSumita
Shares held1013233618
Percentage10%13%23%36%18%
Dividend distribution= Percentage x Total Dividend5000650011500180009000

Mutual Dividend Scheme Payout

Let us look at an example of how the dividend option or the IDCW in mutual funds schemes pay out dividends to its investors. Let us say we have invested in the IDCW in mutual fund and now own 5000 units of that mutual fund. The current net asset value of each of these units is Rs. 200 (cum dividend). Say the investment scheme declares a dividend of 5 rupees per unit. What effect does it have on the investment? The table below gives a break up of the investment and the returns after one year. 

ParticularsAmount
Number of Units5000
NAV (cum dividend)Rs. 200
Investment value Rs. 10,00,000
Dividend per unitRs. 5
Total Dividend received(Number of units x Dividend per unit)Rs. 25000
Ex-dividend NAVRs. 195
Investment value after the dividend payoutRs. 9,75,000

What we can observe from this table is that the investor received Rs. 25000 as dividend payout after one year. But our initial investment value has been reduced by Rs. 25000 too. Thus, we have received only a part of our original investment as a dividend. Had we invested the same amount of money in the growth option of the mutual funds, then our NAV would not have changed because there is no dividend option in the growth option of the mutual funds.

Why should you invest in IDCW or Growth?

So, where and why do we invest in the IDCW or Growth option of mutual funds? There are two viewpoints that we need to consider while making this decision.

  • Goals

Firstly, what is the goal of the investor? If the investor is looking for long-term wealth accumulation, they should opt towards the growth option of the mutual fund schemes. The growth option does not provide payouts and instead reinvests whatever gains are made. This creates a compounding effect on the investment, thus allowing the investor to make gains over some time. 

On the other hand, if the investor is looking for regular cash flow or short-term investment plans, they can opt for the IDCW in mutual funds schemes. But what they need to keep in mind is that the payout of the IDCW is solely on the individual decision of the fund manager or the AMC in charge of the mutual fund schemes. 

  • Tax benefits

The second viewpoint relates to the tax benefits of both schemes. Since the payout of the IDCW in a mutual funds scheme is usually regular, whatever payout is received is included in the investor's income and taxed accordingly. The taxation rate is decided by the slab in which the investor falls. Particularly for higher tax bracket investors, the returns earned on IDCW will be taxed not only as gross income but TDS will also be levied on it. In this sense, IDCW has a huge disadvantage on the Growth option.

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Bottom line

The changing of terms by the SEBI for the dividend option to become IDCW has been a big relief for some new investors as it clearly describes what the option means. To sum it up, IDCW provides an investor with the promise of regular cash flow without any particular gains in their initial investment. At the same time, the cash flow is also subject to the sole discretion of the AMC or the fund manager.

FAQs

  1. Is IDCW better than Growth?

While there is nothing concrete to say which is better, Growth certainly has a few advantages over IDCW.

  1. Does IDCW payout regularly?

The payout frequency of IDCW is solely dependent on the fund manager or the AMC.

  1. Does IDCW payout from profits?

IDCW pays out from the surplus investment accumulated and not from the profits generated.

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