IDCW vs Growth: Which Mutual Fund Option should you Invest in?
The main difference between IDCW and Growth options is that the IDCW option will give you payouts, whereas the Growth option will not give you payouts, instead your money will keep growing until you withdraw it.
Most mutual funds have up to 3 options that you can invest in:
- Growth option
- IDCW option
- IDCW reinvestment option
Many mutual funds offer all the 3 options. The underlying portfolio for all the 3 options is the same. However, your money will grow differently.
In this article, we will explore the differences between the growth and IDCW options of mutual funds and help you choose the best mutual fund option.
What is the IDCW option in mutual funds?
IDCW stands for Income Distribution cum Capital Withdrawal.
Under the IDCW option of mutual funds, the investors receive payouts (that may be periodic) for their investments. The payouts are made from three sources:
- Profits (the rise in prices of the underlying stocks and bonds)
- Income (dividends for stocks and interest for bonds)
- Capital (the initial investment made by the investors)
When you invest a certain sum of money in the IDCW option of a mutual fund, you acquire a certain number of units of the fund. The fund then announces a payout for you and other investors.
Let's look at an example to make this clear.
Example of IDCW option
Suppose you invested ₹1,000 in the HDFC Balanced Advantage Fund IDCW option on 1st April 2023 and acquired 34.05 units at an NAV of ₹29.36.
The fund declared a dividend/payout of ₹0.23 per unit when the NAV was ₹29.92. Since you had 34.05 units, you received a total payout of ₹7.83, and the NAV of the fund went down to ₹29.69 to adjust for the payout.
In this example, the fund made the payout from profit and income generated by the underlying stocks and bonds. Had there been not enough profit and income, the fund would have withdrawn from the capital (the money that you invested), and repaid it to you.
Hence the name: Income Distribution cum Capital Withdrawal Plan.
The IDCW option was earlier called the ‘dividend option.’ But the SEBI changed the name of ‘dividend option’ to ‘IDCW option’ in April 2021 because investors had developed a misunderstanding around ‘dividends’ received from stocks and mutual funds.
Let’s understand this in a little more detail.
Why did the SEBI change the name of ‘dividend option’ to ‘IDCW option’?
Traditionally, dividends refer to a company distributing its profits to its investors or shareholders. Mutual funds used the ‘dividend option’ to indicate that their investors would receive income from their mutual fund investments.
But there’s a problem: Mutual fund ‘dividends’ are not always repaid from profits generated. In fact, mutual fund companies often simply withdraw from the capital (money that people invest) and pay them as dividends.
So ‘dividend option’ in mutual funds was a misnomer or inaccurate use of the term ‘dividend.’ By calling it IDCW, the SEBI made sure that the option’s name accurately represents what happens with your investment.
What is the Growth option in mutual funds?
In contrast to the IDCW option, the growth option doesn’t make any payouts to its investors. Instead, money invested in the growth option of a mutual fund will keep compounding/growing and will be returned to you only if you withdraw it.
Suppose you invested ₹1,000 in HDFC Balanced Advantage Fund Growth Option on 1st April 2023 and acquired 1.35 units at an NAV of ₹739.41
On 23rd May 2023, the value of your ₹1,000 investment would be ₹1,049.04 because the NAV increased to ₹777.06, and the fund retained the profit and income generated by underlying stocks and bonds.
As you can see, the NAV of the IDCW option is much lower than the NAV of the growth option of the fund. This is because the IDCW option has repaid income/capital to its investors multiple times over the years.
Difference between IDCW and Growth options
Now that we know what IDCW and growth options are, let’s compare them in an easy to understand tabular format:
|Parameter||IDCW Option||Growth Option|
|Payouts||Yes, some funds make payouts on a periodic basis||Growth options of mutual funds don't make payouts|
|Offered by||Most mutual fund schemes||All mutual fund schemes offer the growth option|
|Income and profits of underlying stocks and bonds||Income and profits are either paid out or retained||Income and profits are always retained by the fund and reinvest in new/existing stocks and bonds|
|NAV||NAV is lower than growth option of the same fund because income/capital is distributed and results in a fall in the NAV||NAV of growth options is always higher than IDCW option of the same fund because income/capital is retained|
|Purpose||Income generation and capital preservation||Long-term financial goals and wealth creation|
|Taxation||IDCWs are taxed at your marginal income slab rate. However, if you withdraw from the fund, capital gains taxation maybe be applicable depending upon the fund type and holding period||Growth options attract only capital gains taxation depending upon the fund type and holding period|
|Who should invest?||Investors seeking income and capital preservation||Investors with a long-term investment horizon and a higher risk tolerance|
IDCW vs. Growth: What is right for you?
Objectively speaking, IDCW options make very little sense for most investors for the following reasons:
- The IDCW (dividend) is as per the wish of the fund, and investors don't have control over the timing and quantum of the IDCW
- IDCW is tax-inefficient especially for investors in the higher tax brackets
- SWP or Systematic Withdrawal Plan is a better plan than the IDCW option since it allows you to control the timing and quantum of payments and is more tax efficient than the IDCW option
The growth option is better than IDCW in almost all cases. It is best to consult a financial advisor to understand if the IDCW option of mutual funds makes sense for you.
IDCW vs. Growth: Frequently Asked Questions
What is the full form of IDCW?
IDCW stands for Income Distribution cum Capital Withdrawal.
What is the difference between the IDCW option and SWP?
The IDCW option makes payouts (some funds pay periodically) from the fund's profits, income or your invested capital. The timing and quantum of these payouts is out of your control. On the other hand, with the SWP (Systematic Withdrawal Plan), you can get tax-efficient payouts and control their timing and quantum.
Can we convert the IDCW option to the Growth option?
Yes, converting from the IDCW option to the Growth option is easy. You need to place a ‘switch’ transaction in the fund so money is transferred to the growth option from the IDCW option. Note: Switch may result in a taxation incident.