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When investing in a mutual fund scheme, investors can choose from either growth or dividend options. Also, in the dividend option, the investors will receive dividends for the profits from the underlying mutual fund scheme. Thus, the profits can be reinvested or made available to investors. However, investors have some misconceptions about how dividends are paid from mutual fund schemes. Therefore, SEBI has introduced IDCW in mutual funds for better clarity. In this article, we will discuss IDCW (Income Distribution Cum Capital Withdrawal) in mutual funds to also clear the misconception about dividend options in mutual funds. 

What is IDCW in Mutual Fund?

The full form of IDCW in mutual funds is ‘Income Distribution Cum Capital Withdrawal’. This was formerly known as ‘Dividend Option’ in mutual funds where investors can opt for dividend payout or dividend reinvest. Therefore, in April 2021, SEBI introduced this name change where mutual fund investors came across this new term IDCW.

Income Distribution Cum Capital Withdrawal (IDCW) refers to income distribution from a mutual fund scheme which includes dividends paid by stocks and also capital gains earned by selling the underlying stocks in the scheme portfolio. Therefore, if you have invested in any mutual fund scheme under the dividend option, you will notice IDCW next to the mutual fund scheme name in your statement of account (SOA). However, this is only a change in terminology and has no impact on investors. 

SEBI has proposed the renaming of dividend option as per the following – 

Existing Option/PlanNew Terminology
Dividend Payout  Payout of Income Distribution cum capital withdrawal option
Dividend Reinvestment  Reinvestment of Income Distribution cum capital withdrawal option
Dividend Transfer Plan  Transfer of Income Distribution cum capital withdrawal plan

How Does IDCW in Mutual Fund Work?

To understand how IDCW works in mutual funds, let’s refer to the illustration below. Also, this is a break-up of income and capital distribution in the monthly CAS sent to the investors. 

Record Date30-Mar-21
Dividend Rate7
Cum NAV on record Date20
Total Units2,188.41
Total Dividend15,318.84
Dividend out of capital6,985.51
Dividend out of appreciation8,333.33
Investor 1:Calculation for record date 30 March, 2021
DateAmount InvestedSubscription NAV (A)Subscription UnitsMovement in NAV from the date of investment to record dateDividend declaration RateCapital utilised to pay dividend (per unit) (B)Dividend paid out of appreciation in NAV (per unit)Dividend amount paid out of capital (INR)Dividend amount paid out of appreciation (INR)
21-Jan-2112,000.00121000.0087070.007,000.00
21-Feb-8512,000.0018666.6727523,333.331,333.33
25-Mar-2112,000.0023521.7407703,652.170.00
2,188.416,985.518,333.33

Note: For the above calculations, in case if capital is utilised to pay a dividend, subscription NAV will be adjusted only for those dividends declared on or after 1st April 2021. However, no such adjustments will be made for dividends declared after 1st April 2021.

Capital Amount Adjustment

After each distribution, the capital amount is adjusted (A-B) in order to arrive at the correct bifurcation for the next distribution as shown below – 

Record Date30-April-21
Dividend Rate5
Cum NAV on record Date15
Total Units2,188.41
Total Dividend11,463.77
Dividend out of capital6,608.70
Dividend out of appreciation4,855.07
Investor 1:Calculation for record date 30 April 2021
DateAmount InvestedAdjusted Subscription NAVSubscription Units in the form of NFO purchase/Switch/Div Reinvestment/Dividend TransferMovement in NAV from the date of investment to record dateDividend declaration RateCapital utilised to pay to dividend (per unit) (B)Dividend paid out of appreciation in NAV (per unit)Dividend amount paid out of capital (INR)Dividend amount paid out of appreciation (INR)
21-Jan-2112,000.0012 (12-0)1000.0035232,000.003,000.00
21-Feb-2112,000.0013 (18-5)666.6725322,000.001,333.33
25-Mar-2112,000.0016 (23-7)521.74-15512,608.70521.74
2,188.416,608.704,855.07

Interpretation

  1. The NAV at which the investor subscribes to the fund which is also the cost of capital for disclosure. In the case of multiple transactions, subscription NAV for each translation will also be considered as capital for that lot. 
  2. At the time of each distribution, the ex-date cum dividend NAV will also be compared with capital contribution (as per point 1) at each unitholder level.
  3. The difference between cum dividend NAV and also capital shall be positive. If it is positive, it will be considered as income and also distributed from the appreciation in NAV. If it is negative, everything will be considered from capital distribution. In other words, it is distributed from equalisation reserve.
  4. Any balance amount to distribute will be considered from the capital, i.e. distributed from equalisation reserve.
  5. After each distribution, the capital amount at the unitholder level will also be adjusted to arrive at the correct bifurcation for the next distribution. 

Why SEBI Changed From Dividend To IDCW in Mutual Fund?

Dividends are additional gains that you receive over and above your investment. However, this was not the case for mutual funds. When you receive profits from your mutual fund scheme, at the same time, the NAV of the fund is reduced by the same amount. In reality, there is no gain or additional payout, and this scenario leads to withdrawing your own capital. Therefore, SEBI has renamed the gain as ‘distribution’. 

Additionally, investors are not aware of the difference between income distribution and capital distribution. Income distribution means appreciation of NAV, and capital distribution means mount in equalisation reserve or investor’s capital.

In simple words, SEBI wanted to emphasise that the income is coming from your investment capital only. Therefore, Income distribution cum capital withdrawal IDCW is more accurate in explaining differences and promoting transparency of mutual fund dividends. Also, there will be no misconceptions of mutual fund dividends in your mind. 

Difference Between Dividend Declared by AMCs and Companies

Even though the name is the same, dividend meaning differs for AMCs and companies. The following are the major differences between the two – 

CompanyAMC
Declaring dividends is not mandatory for companies. Also, it is at their discretion whether to declare it or not. Therefore, if companies declare, they must follow specific guidelines under the Companies Act.All mutual fund schemes must declare dividends at least once a year. Also, Dividend payout mutual fund schemes distribute dividends periodically like quarterly, half-yearly or annually.
Whenever a company declares a dividend, the share price may decline or not.The NAV falls by the same amount whenever a mutual fund pays out dividends. 
Companies have a right to decide what part of profits are paid to shareholders. All accumulated profits eventually belong to the unitholders. Hence, AMC only has the right to determine the dividend rate. 

Things To Consider About IDCW in Mutual Fund

  • Misconception 1
    When mutual funds pay dividends to investors, they are actually paid by the underlying stocks in the scheme portfolio
    Reality – When mutual fund schemes pay dividends, it may also include the dividends received from the underlying stocks in the portfolio holding. Also, it may include the profits booked by selling the stocks in the portfolio. 
  • Misconception 2
    When investors receive dividends from mutual funds, it is an extra income over and above the capital appreciation.
    Reality – When investors receive dividends from mutual funds, it is not an extra income over and above the profits that investors make on redemption. Mutual funds dividends are instead of capital appreciation which is ultimately paid from the investor’s capital. Therefore, the NAV of the dividend scheme falls to the extent of dividends paid to investors.  
  • Misconception 3
    Dividend option mutual fund schemes book profits regularly to pay dividends to investors
    Reality – The underlying mutual fund scheme portfolio is the same for any option, i.e. growth or dividend. Thus, when the fund manager books profit, it happens at a scheme level for all options – growth, dividend, or other options. The actual difference lies in the distribution of profits like – 
    • In the growth option, the profits are reinvested in the scheme, and also the same reflects in the NAV of the growth option of the scheme.
    • In the dividend option (now known as IDCW), a portion of the profit is distributed to the investors which is also at the discretion of the fund manager or AMC. However, investors must note that the mutual fund scheme profit distribution is not mandatory for the AMC to pay investors under the dividend option. 

Who Should Opt for the IDCW in Mutual Funds?

IDCW in mutual funds best suits the investors who want regular income from their investment. Also, the IDCW from these mutual funds is not very significant, but they cannot be ignored. Generally, retired investors want regular cash flows where they can opt for the IDCW option knowing that the income distribution is solely dependent on the discretion of the fund manager or AMC. Also, it depends on the performance of the underlying companies and market movements, and there is no guarantee of IDCW payouts in mutual funds. 
In addition, investors with low-risk tolerance levels can prefer to invest in IDCW in mutual funds as they look for stable returns. Also, during the bear market phase, they can provide some dividends to the investors. Furthermore, from the taxation viewpoint, the IDCW income is added to the investor’s taxable income and is subject to normal tax slab rates. Also, there is TDS on IDCW if the total dividend exceeds INR 5000. On the other hand, if the investment objective is a capital appreciation for the long term, then investors must opt for a growth option for significant returns. 

To conclude, this article addresses the misconceptions that mutual fund investors have about mutual fund dividend options, known as IDCW. Therefore, SEBIs change in terminology is to clarify the wrong misconceptions about mutual fund dividends. 

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