IDCW vs Growth Option in Mutual Funds

What is IDCW in Mutual Fund?

Income Distribution cum Capital Withdrawal (IDCW) involves redistributing part of the income earned by the fund, along with a potential withdrawal from the invested corpus. From April 1, 2021, the Securities and Exchange Board of India (SEBI) renamed the dividend option in mutual funds to IDCW. This change was introduced to make it clear to investors that the payouts they receive are not just from profits, but can also include a portion of their invested capital. 

Whenever a mutual fund has a distributable surplus, the Asset Management Company (AMC) reinvest it in the scheme or distribute it among investors. When such a distribution happens, it is shared in proportion to the number each investor holds. Once this payout is made, the fund's Net Asset Value (NAV) reduces by the exact distribution amount, because money has been taken out of the scheme. 

Investors can choose to receive the payout in cash at regular intervals (IDCW Payout) or have it reinvested into the fund to buy additional units (IDCW Reinvestment). In both cases, the NAV decreases, but under the reinvestment option, the number of units increases.

Consider a simple illustration. Suppose you invest ₹10,000 in a mutual fund at a NAV of ₹20, giving you 500 units. 

After one year, the NAV rises to ₹25. The AMC declares an IDCW of ₹5 per unit, so you receive ₹2,500 as payout. 

Following this distribution, the NAV falls back to ₹20, leaving your 500 units worth ₹10,000. Your total value is therefore ₹12,500, ₹10,000 still invested in the fund and ₹2,500 received as cash. 

The key point is that only ₹10,000 remains in the scheme to generate future growth, while the payout has reduced the compounding potential of your investment.

What is the Growth Option in Mutual Funds?

When you choose the Growth Option in a mutual fund, all profits, interest income, and capital gains are retained within the scheme instead of being distributed as payouts. This reinvestment steadily increases the Net Asset Value (NAV) over time and allows your investment to benefit fully from the power of compounding. Unlike IDCW, there are no interruptions to growth, which makes this option highly effective for long-term wealth creation.

For example, suppose you invest ₹10,000 at a NAV of ₹20, giving you 500 units. After a year, the NAV rises to ₹25. Since no dividend is declared, you do not receive any cash, but the value of your investment automatically rises to ₹12,500. The entire amount remains to stay invested, compounding further as the NAV grows with market performance.

IDCW vs Growth Option in Mutual Funds: The Core Differences

Here’s a detailed comparison of IDCW vs Growth options in mutual funds:

IDCW vs Growth Option in Mutual Funds: Taxation

Here’s a detailed comparison of IDCW vs Growth options in mutual funds with a focus on taxation:

Who Should Choose IDCW vs Growth?

The following is a table of aspects of both options that each party may find more appropriate:

IDCW Option may suit investors who:

• Need periodic cash flow: Retirees or investors who rely on investments to cover monthly or quarterly expenses.

• Prefer visible income: IDCW creates the impression of stability through payouts, though these are not assured and reduce future compounding.

• Short-term goals: Useful when funds may be needed soon, as payouts can help with liquidity without redeeming units.

Note: IDCW does not make the underlying investment less risky. The portfolio risk is the same as in Growth; the only difference is that cash is taken out periodically.

Growth Option may suit investors who:

• Focus on wealth creation: Beneficial for long-term investors, as reinvested earnings compound without interruption.

• Seek tax efficiency: Tax applies only at redemption. For equity funds, gains are taxed at concessional rates (20% STCG, 12.5% LTCG above ₹1.25 lakh for transfers made on or after 23 July 2024).

• Plan for long-term goals: Suitable for retirement, children’s education, or home purchase, where wealth accumulation matters more than interim cash flows.

• Can tolerate market swings: Willing to withstand short-term volatility in exchange for higher potential returns.

Factors to Consider Before Choosing IDCW vs Growth Option in Mutual Funds

Here are the key points to weigh before deciding between IDCW and Growth:

• Investment Goals: The Growth Option is better suited if your primary objective is long-term wealth creation, as all earnings are reinvested and benefit from compounding. IDCW, on the other hand, works for investors who prefer regular cash flow to meet short-term financial needs.

• Income Requirement: If you do not require frequent payouts, the Growth Option allows your money to grow uninterrupted. But if you depend on periodic income to supplement expenses, IDCW can provide that, though the amounts and timing of payouts are not guaranteed.

• Risk Tolerance: The Growth Option may deliver higher returns over time, but it requires patience and the ability to withstand short-term market volatility. IDCW feels relatively safer for conservative investors, as payouts provide a cushion, but this comes at the cost of reduced compounding and lower overall growth potential.

Key Takeaways

The choice between IDCW vs Growth option in mutual funds depends on your financial goals. The IDCW option provides regular payouts, but these are fully taxable at slab rates and reduce post-tax returns. The Growth option reinvests earnings, compounds wealth, and taxation applies only at redemption. This makes it more efficient for long-term wealth creation. If you are ready to invest smartly, you can start SIP in the best mutual funds in India.