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What is IDCW Plan in Mutual fund & How Does It Impact Returns?

9 Mins 25 Jul 2023 0 COMMENT

If you have been a long-term investor in mutual funds, you might have heard about the Dividend Option that mutual fund companies offer. In this option, dividends are not reinvested and instead distributed among unitholders.

IDCW or Income Distribution cum Capital Withdrawal is just the new name for this option. The Securities and Exchange Board of India (SEBI) changed the name of this option in April 2021. This is only a change in terminology and as such, there is no impact on investors.

Why did the Sebi change the name?

SEBI just wanted to bring more clarity to investors. When someone less savvy about investments hears the Dividend Option, it gives a sense that such mutual funds will also pay dividends like companies pay that to shareholders. However, this is far from the truth.

The new name, though a little longer, emphasises that this income that is distributed to unitholders is coming out of investors’ own money – which includes the dividend paid by the companies and returns generated on the investment.

According to the SEBI, all such plans are named accordingly:

Option/ Plan

New name

Dividend Payout

Payout of Income Distribution cum capital withdrawal option

Dividend Re-investment

Reinvestment of Income Distribution cum capital withdrawal option

Dividend Transfer Plan

Transfer of Income Distribution cum capital withdrawal plan

How do IDCW plans differ?

The key difference between IDCW plans and Growth option plans is that the former regularly distribute income among unitholders. In the latter option, the income in the form of dividends is reinvested.

Thus, the growth option gets the benefit of compounding as all extra income is used to purchase more equity. However, the impact of compounding is not efficiently visible in the IDCW option.

Investors should also not have any misconception that dividends paid by IDCW mutual funds are actually paid by the underlying stocks. They can be dividends and any return generated on investment after the fund manager books gains.

Furthermore, there should be no misconception that payout in IDCW is extra income above the market return generated on investment. Every time dividends are paid out, the net asset value (NAV) of IDCW plans is reduced by the extent of the dividend paid to investors.

How does the dividend paid by IDCW plans impact returns?

Since NAV is negatively impacted when an IDCW plan pays out dividends to unitholders, overall returns are relatively lower compared to growth option of the same fund. NAV reflects how much capital appreciation has happened in a fund over time.

Let us understand how dividend distribution impacts the return by the following illustration:

Let us assume that you are an investor in the IDCW option of a large-cap fund. Assuming the current NAV of the fund is Rs 10 and you hold 1,000 units of the fund. The total value of the investment right now is Rs 10,000.

Particulars

Amount

Number of Units

1,000

NAV (before dividend payout)

Rs 10

Investment Value

Rs 10,000

Dividend per unit

Re 1

Total dividend received (units X dividend per unit)

Rs 1,000

NAV after dividend payout

Rs 9

Investment value after dividend payout

Rs 9,000

 

The fund manager of the largecap fund pays Re 1 per unit divided (this means a 10 per cent yield) to unitholders. The NAV of the fund will be adjusted to Rs 9 per unit to reflect the dividend payout. Moreover, you can note that if you include the dividend paid to you and the value of the investment after the dividend payout, it is equal to the value of the investment before the dividend payout.

Should you invest in the IDCW option?

The answer depends on your needs. For instance, if you are a salaried person who does not need additional income every month or at periodic intervals, opting for the IDCW option makes no sense. Investing in growth options that benefit from compounding over time will be perfectly fine.

However, there are certain scenarios where this option can work. For example, if you have invested in a mutual fund for the sole goal, for instance paying tuition fees for your kid, then IDCW is not a bad choice.

If you are a retired individual and need a periodic income to pay bills, it makes sense to invest in the IDCW option as this option tends to generate a regular income for you and also provides capital appreciation.

Please keep in mind that equity IDCW are risk prone and returns or dividend payout is dependent on market conditions. Consult a financial advisor if you are confused about whether the IDCW option fits your needs.

Disclaimer: ICICI Securities Ltd. (I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. I-Sec is a Member of National Stock Exchange of India Ltd (Member Code :07730), BSE Ltd (Member Code :103) and Member of Multi Commodity Exchange of India Ltd. (Member Code: 56250) and having SEBI registration no. INZ000183631. AMFI Regn. No.: ARN-0845. We are distributors for Mutual funds. Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. Name of the Compliance officer (broking): Ms. Mamta Shetty, Contact number: 022-40701022, E-mail address: complianceofficer@icicisecurities.com. Investments in securities markets are subject to market risks, read all the related documents carefully before investing. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investors should consult their financial advisers whether the product is suitable for them before taking any decision. The contents herein mentioned are solely for informational and educational purpose.