What is IDCW in Mutual Funds? Does it Make Sense to Opt for it?

Under the IDCW option, mutual funds distribute profits/income earned under the scheme back to investors as dividends instead of reinvesting them in the scheme. These earnings may arise out of dividends paid by stocks in the underlying portfolio and capital gains made by selling stocks from the portfolio.

Why did SEBI change the terminology from Dividend option to IDCW option?

It is a common perception among investors that dividends from mutual funds are extra income over and above the capital appreciation. In reality, dividends declared by mutual funds are a part of the scheme's earnings (such as dividends from stocks, interest from bonds, and capital gains) and the same is paid from investors' capital. In other words, this income comes out of investors' accumulated value. Accordingly, the NAV of the scheme falls to the extent of dividends paid to investors.

So, to avoid misconception in the minds of the investors and to help them take more informed investment decisions, SEBI changed the nomenclature to IDCW from Dividend. This marks only a change in terminology and has no impact on investors who opted for the IDCW option.

What is the Difference between IDCW and Growth Option?

The underlying portfolio across the Growth and IDCW options is always the same. Thus, when a stock in the portfolio declares dividend or if the fund manager books profit in any stock, it gets reflected at the scheme level across Growth and IDCW option. The difference between the two lies in how the scheme distributes the profit.

In the case of Growth option, the fund manager reinvests the profits earned back into the scheme. In the case of IDCW option, the fund manager may distribute a portion of the profit to investors which results in decline in NAV to that extent. The scheme may announce dividend monthly, quarterly, yearly, etc. at the discretion of the fund manager/AMC. It is important to note that announcing dividend is not mandatory and the scheme/AMC may choose to decide against distribution of profit.

What is the difference in dividends declared by mutual funds and companies?

When companies declare dividend, it means that they decide to return some of the profit earned by them to their shareholders. The company's management decides the part of profit to be distributed to investors and the part to be retained for its future growth. In other words, when a company declares dividend, the profits are shared with the shareholders directly from the company's earnings, reflecting its profitability.

However, in the case of mutual funds, dividends work differently. When a scheme earns income from its underlying holdings, it either reinvests them or distributes them to its investors. These earnings may include profits or capital withdrawals. If the scheme decides to distribute the earnings, it is done from the fund's net asset value (NAV) because IDCWs are units of the fund that represent the investor's share of the profits.

Here is how IDCW calculation works...

Let us assume that an investor owns 1,000 units of XYZ mutual fund scheme. The current NAV (cum dividend) of the scheme is Rs 50. Assuming the scheme declares a dividend of Rs 2 per unit. As mentioned earlier this not a bonus/extra amount and the amount paid as dividend will be reduced from your investment.

After declaration of dividend the NAV per unit will drop to Rs 48 and the Investment value after dividend payout will now be Rs 48,000 compared to a value of Rs 50,000 in case of Growth option. This clearly highlights that IDCW is just distribution of portion that already belongs to the investor.

Taxation of IDCW option

Income received by investors as IDCW is added to their gross income and taxed according to the applicable income tax slab. For instance, if an investor falls under the highest tax bracket, he/she will have to pay tax on IDCW earnings at the rate of 30%. There is also TDS at 10% on IDCW if the total dividend amount exceeds Rs 5,000 in a financial year. Notably, in the Union Budget 2025-26 this threshold has been increased to Rs 10,000.

In the case of Growth option, income is subject to capital gains tax only when investors redeem the units.

Growth vs IDCW option: Which one should investors choose?

When investors opt for the growth option, the profits made by the scheme remain invested in the scheme. Over a period, the invested capital and the profit earned compounds the wealth, resulting in significant wealth creation.

The IDCW option in mutual funds offers investors the benefit of withdrawing profits earned by a mutual fund, as dividends, at certain intervals. However, since there are periodic payouts in IDCW, it hurts the power of compounding to an extent.

Thus, the growth option is suitable for investors aiming for accumulation and steady growth of capital over the long run. Those looking for periodic payouts from mutual fund schemes can opt for IDCW. But remember that payouts are not guaranteed and the fund may even skip declaring IDCW.

To conclude...

IDCW and Growth option cater to the need of investors with distinct needs. When deciding between the two options it is important to consider various factors and choose the one that best aligns with your investment objectives and your liquidity needs. Also take into consideration the taxation aspects to make the right choice.

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DIVYA GROVER is the co-editor for FundSelect, the flagship research service of PersonalFN. She is also the co-editor of DebtSelect. Divya is an avid reader which helps her in analysing industry trends and producing insightful articles for PersonalFN’s popular newsletter – Daily Wealth letter, read by over 1.5 lakh subscribers.
Divya joined PersonalFN in 2019 and has since then used stringent quantitative and qualitative parameters to analyse funds to provide honest and unbiased research to investors. She endeavours to enable investors to make an informed investment decision and thereby safeguard their wealth.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.