What is IDCW in Mutual Funds?

‘IDCW’ is abbreviation of ‘Income Distribution cum Capital Withdrawal’. Mutual fund investors have come across this new term IDCW when SEBI changed the term “Dividend Option” in mutual funds to “IDCW” in April 2021.

If you had invested in any mutual fund scheme under dividend Option, you will now notice IDCW next to the mutual fund scheme name in your statement of account (SOA) sent by the AMC. This is only a change in terminology and as such there is no impact on investors.

Why SEBI changed Dividend to IDCW?

Income Distribution cum Capital Withdrawal or IDCW refers to distribution of income of a mutual fund scheme, which may include both dividends paid by stocks and capital gains made by selling underlying stocks from the scheme portfolio. However, SEBI also wanted to emphasize that this income is coming out of the investor’s investment value only. In other words, it amounts to withdrawal of capital. According to SEBI, the term IDCW is a more accurate description of mutual fund dividends and that there should be no misconception about mutual fund dividends in the mind of the investors.

What are the misconceptions about mutual fund dividends in India?

Misconception 1 - Dividends paid by mutual funds are actually paid by the underlying stocks in the scheme portfolio

Reality – Dividend paid by mutual fund schemes may also include dividends received from the underlying stocks in the scheme portfolio holding. It may also include the gains booked by selling stocks in the scheme portfolio.

Misconception 2 – Dividends received from mutual funds are extra income over and above the capital appreciation

Reality – Dividends received from mutual funds are not extra income or return over and above the gains investors make on redemption. Mutual fund dividends are in lieu of capital appreciation and the same is paid from investor’s capital. This is the reason the NAV of the dividend scheme falls by the extent of dividend paid to investors.

Misconception 3 – Dividend options of mutual fund schemes book profits regularly to pay dividends.

Reality – The underlying scheme portfolio of growth, dividend or any options of a mutual fund scheme is the same. When profit is booked by the fund manager it happens at a scheme level i.e. for all the options – growth, dividend or any other option. The difference lies in distribution of the scheme profits – If you have chosen growth option, the profits are re-invested in the scheme and reflects in the NAV of growth option of the scheme whereas in the dividend option (now known as IDCW), a portion of the profit may be distributed to the investors at the discretion of the fund manager/AMC. Investors should note that distribution of scheme profit is not mandatory for the AMC to pay to the investors in the dividend option.

Is there any difference between dividends declared by mutual funds and companies?

Even though dividends (now known as IDCW) declared by mutual fund schemes may seem or sound similar to that of dividends declared by companies, there are major differences between the two -

  • Companies pay dividends from the Profit after Tax (PAT). Generally companies declare dividends after retaining a part of the profit which goes to the reserves and surplus account of the company for future growth. The company management decides what portion of the profits should be paid as dividends to shareholders and how much should go to the reserve and surplus account.
  • Mutual fund schemes can pay dividends only from the accumulated profits of the scheme. The AMC decides the dividend (IDCW) payout rate per unit. But whether the scheme pays dividends or not, the accumulated profits of a scheme belong to the investors and are reflected in the NAV (Net Asset Value) of the scheme.
  • The Net Asset Value (NAV) of a scheme will always go down after dividend is paid out. The NAV will fall proportionally and get readjusted after the dividend is paid. We will see that in the example below. In contrast, the share price of a company may or may not go down after dividends are declared.

Example of a mutual fund scheme dividend payout

Suppose an investor owns 1,000 units of a mutual fund scheme. The current NAV (cum dividend) of the scheme is Rs 100. Assuming the scheme declares a dividend of Rs 5 per unit, let us see how his/her investment value can get impacted -

Number of Units1,000
NAV (cum dividend)Rs 100
Investment ValueRs 100,000
Dividend per unitRs 5
Total dividend received (no. of units x Dividend per unit)Rs 5,000
Ex-Dividend NAVRs 95
Investment Value after dividend payoutRs 95,000

You can see that dividend received by the investor was not extra. It came out of his/her investment value only. If he/she had invested in the growth option of the mutual fund scheme, the value of his/her investment would have been Rs 100,000 instead of Rs 95,000. This is because in the growth option there is no dividend disbursement.

This is the reason why SEBI changed the term ‘dividend’ to IDCW in mutual funds so that investors can make more informed investment decisions while investing in mutual fund dividend option.

Should the investor invest in Growth or IDCW option?

It can be decided based on the following considerations:-

  • In Growth Option, the profits made by the scheme remain invested in the scheme. Over sufficiently long investment tenures, the investor can earn profit on profits and so on. Also known as power of compounding, this can have a significant factor in wealth creation for the investor.
  • In IDCW, the profits made by the scheme may be distributed to the investor partially or fully at the discretion of the fund manager / AMC. In the IDCW option you lose the advantage of compounding as the investors periodically receives the IDCW payouts.
  • If investors’ investment objective is capital appreciation or long term wealth creation, they should invest in growth option of the mutual fund scheme.
  • If the investors’ want regular cash-flows from their investments, then they may opt for IDCW option knowing fully well that the income distribution is at the sole discretion of the fund manager/ AMC and that there is no guaranteed of IDCW payouts in mutual funds.
  • Taxation disadvantage of IDCW - Capital gains upon redemptions in growth option are subject to capital gains tax. Short term capital gains in equity funds (investment holding period of less than 12 months) are taxed at 15% (plus applicable surcharge and cess). Long term capital gains in equity funds (investment holding period of more than 12 months) are tax exempt up to Rs 100,000 and taxed at 10% (plus applicable surcharge and cess) thereafter. In debt funds, short term capital gains (investment holding period of less than 36 months) are added to your income while long term capital gains (investment holding period of more than 36 months) are taxed only at 20% after allowing indexation benefits.

  • Income received by the investor as IDCW is added to the gross taxable income and taxed according to the income tax slab rate of the investor. Therefore, from a taxation viewpoint also, IDCW is at a significant disadvantage over the growth option, particularly for the investors in the higher tax brackets. There is also TDS on IDCW if the total dividend amount exceeds Rs 5,000.

We tried addressing the misconceptions that mutual fund investors may have about mutual fund dividends which is now known as IDCW. SEBI’s change in terminology from Dividend to IDCW is aimed at clarifying the wrong perceptions about mutual fund dividends.

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