IDCW vs Growth

The IDCW option offers investors a steady income stream through regular dividend payouts, while the growth option of mutual funds prioritises capital appreciation and the compounding effect. These two distribution choices, IDCW and Growth, present distinct approaches to wealth accumulation in the mutual fund landscape.

In this article, we explore the disparities between IDCW and Growth options, analysing their features, benefits, and implications for investors. By shedding light on these alternatives, investors can make informed decisions aligned with their financial goals and risk preferences, ensuring a tailored investment approach tailored for long-term prosperity.

What is the growth option?

The growth option in mutual funds is the one where you do not receive any regular pay-outs from the fund. Instead, all the profits made by the fund are reinvested in the scheme, increasing the value of your units. This means that you can benefit from the power of compounding, as your money grows faster over time. The growth option is suitable for investors who have a long-term horizon and do not need any regular income from their investments.

What is the IDCW (income distribution cum capital) option?

The income distribution cum capital withdrawal or IDCW option in mutual fund is the one where you receive regular pay-outs from the fund. These pay-outs are called income distribution cum capital withdrawal or IDCW, and they are a part of the profits made by the fund. The IDCW option is suitable for investors who need regular income from their investments, such as retirees or those who have short-term goals. It is important to note that regular payout is not guaranteed. Fund manager can declare dividends only when then fund generates surplus funds.

What are the differences between IDCW and growth options in mutual funds?

There are some key differences between IDCW and growth options in mutual funds, such as:

• Returns: The IDCW option gives you lower returns than the growth option, as you receive only a part of the profits made by the fund. The growth option gives you higher returns, as you benefit from the compounding effect of reinvesting the profits.
• Risk: The IDCW option reduces your risk, as you receive regular pay-outs from the fund, which can act as a cushion in case of market volatility. The growth option increases your risk, as you are exposed to the full fluctuations of the market, and you do not receive any pay-outs to offset the losses.
• Liquidity: The IDCW option gives you higher liquidity, as you can access your money anytime through the pay-outs. The growth option gives you lower liquidity, as you have to redeem your units to access your money, which may incur exit load or capital gains tax.

Key features of IDCW

1. Regular payouts: IDCW in mutual funds offers investors regular payouts from the profits generated by the fund. These payouts can be considered income for the investor, distributed at set intervals (monthly, quarterly, etc.).
2. Capital withdrawal component: A part of the IDCW may include a return of the invested capital, not just profits, allowing investors to withdraw their principal over time.
3. Tax implications: IDCW payouts are taxed at the investor's applicable tax slab, making it essential for investors to consider their tax liability when opting for this plan.
4. Market-dependent: The frequency and amount of IDCW payouts depend on the fund's performance, meaning they can fluctuate based on market conditions.

Key features of the growth option

1. No regular payouts: In the growth option of mutual funds, profits earned are reinvested back into the fund rather than being paid out to investors. This allows for the capital to grow over time.
2. Capital appreciation: Investors benefit from the compounded growth of their investments, as returns accumulate and add to the investment value over the long term.
3. Higher NAV: The Net Asset Value (NAV) in the growth option tends to be higher compared to IDCW (Income Distribution cum Capital Withdrawal) because the profits are reinvested instead of distributed.
4. Tax-efficient: The growth option can be more tax-efficient for long-term investors since gains are realized only when units are redeemed, potentially qualifying for lower long-term capital gains tax rates.

IDCW vs Growth – Example

The following example will help us understand the changes in the value of the investment in IDCW vs growth plan after the dividend is declared. 

Detailed comparison between IDCW and growth options

1. Nature of returns

The Income Distribution cum Capital Withdrawal (IDCW) option offers periodic payouts from the fund’s distributable surplus. These distributions are made at the discretion of the fund and are not guaranteed. Conversely, the growth option does not distribute returns. Instead, the earnings are reinvested into the fund, enabling the capital to compound over time.

2. Tax implications

In IDCW, investors are taxed on the distributed income based on their respective income tax slab. The fund house deducts Tax Deducted at Source (TDS) before payouts. Growth options are taxed upon redemption, with taxation determined by the duration of the investment—short-term or long-term capital gains tax rates apply, varying based on the asset class.

3. Suitability based on investment goals

IDCW suits investors seeking periodic income, such as retirees or those with specific financial goals. Growth is ideal for those aiming for long-term wealth accumulation as it allows returns to compound, benefiting investors with a higher risk tolerance and extended investment horizons.

4. Impact on NAV

In the IDCW option, payouts reduce the Net Asset Value (NAV) as the distributed amount is deducted from the fund's assets. Growth options maintain a higher NAV because all profits are reinvested, reflecting the fund’s increased value over time.

Who should choose the IDCW option?

• Investors seeking regular income
  IDCW is suitable for individuals requiring consistent payouts to meet financial needs, such as retirees or those supplementing monthly income. These distributions can act as an alternative to fixed deposits or rental income.
• Risk-averse investors
  Individuals with low risk tolerance may prefer IDCW as it offers periodic liquidity, allowing access to a portion of profits without redeeming units.
• Short-term investment goals
  If your goal is to generate returns over a shorter horizon, IDCW provides intermittent payouts while preserving the capital invested.
• Tax slab advantages
  Investors in lower income tax brackets can benefit as IDCW payouts are taxed based on personal tax slabs, potentially reducing overall tax liabilities compared to capital gains taxation.

Who should choose the growth option?

• Investors aiming for wealth creation
  Growth options are tailored for long-term investors who prioritise capital appreciation. Compounding ensures that reinvested returns generate higher overall growth.
• Tax-efficient investment
  Growth options are more tax-efficient for investors in higher tax brackets as gains are taxed only upon redemption, allowing deferment of tax liabilities.
• Aligned with long-term financial goals
  Suitable for goals such as children’s education, retirement, or homeownership, where consistent growth over time is prioritised over periodic income.
• Higher risk tolerance
  Investors who can handle market fluctuations and are comfortable foregoing periodic income in favour of future growth should opt for the growth option.

Impact on portfolio management: IDCW vs Growth

The IDCW option requires frequent tracking and reinvestment of payouts, increasing administrative efforts. This option can hinder compounding benefits, as regular payouts reduce the amount available for growth. Moreover, IDCW is better suited for a conservative portfolio focused on income generation.

In contrast, the growth option simplifies portfolio management by reinvesting returns automatically. This strategy is aligned with long-term goals and mitigates the need for regular monitoring. Growth enables a focus on total portfolio appreciation, offering compounding benefits and aligning with aggressive wealth-building strategies.

Taxation on IDCW and growth options

The taxation on IDCW and growth options in mutual funds varies depending on the type of fund and the holding period. Here are some basic rules:

• For equity funds, the IDCW is tax-free in the hands of the investor. The growth option is taxed at 15% for short-term capital gains (STCG) and 10% for long-term capital gains (LTCG), with a threshold of Rs. 1 lakh.
• For debt funds, the IDCW is added to the income of the investor and taxed as per the applicable slab rate. The growth option is taxed at the slab rate for STCG and 20% with indexation benefit for LTCG.
• For hybrid funds, the taxation depends on the proportion of equity and debt in the fund. If the equity component is more than 65%, the fund is treated as an equity fund. If the equity component is less than 65%, the fund is treated as a debt fund.

Growth vs. IDCW mutual funds: which is better?

There is no definitive answer to which option is better, as it depends on your investment objective, risk appetite, time horizon, and tax status. However, some general guidelines are:

• Choose the growth option if you have a long-term goal, such as retirement, child’s education, or wealth creation. This option will help you maximise your returns and benefit from the power of compounding.
• Choose the IDCW option if you have a short-term goal, such as emergency fund, vacation, or debt repayment. This option will help you generate regular income and reduce your risk. It is important to note that there is no definite income at regular interval. The income will be paid out if there is any distributable surplus.
• Choose the growth option if you are in a lower tax bracket, as you will pay less tax on your capital gains when you redeem your mutual fund units. Choose the IDCW option if you are in a higher tax bracket, as you will pay less tax on your pay-outs, which are treated as dividends.

Is It possible to switch from the IDCW option to the growth option or vice versa?

Yes, it is possible to switch from the IDCW (Income Distribution cum Capital Withdrawal) option to the Growth option, or vice versa, within the same mutual fund scheme. Most mutual funds allow investors to switch between these two options. However, there are a few important considerations:

1. Tax implications: Switching between the IDCW and Growth options is treated as a redemption and a new investment for tax purposes. This means that capital gains tax may apply based on how long you held the fund before switching.
2. Exit load: Some mutual funds may charge an exit load if you switch options within a certain period. Be sure to check the fund’s terms for any applicable fees.
3. NAV difference: The Net Asset Value (NAV) of the Growth and IDCW options may vary, so the number of units you hold after switching may be adjusted accordingly.

Conclusion

IDCW and growth are two options that you can choose when you invest in a mutual fund. Both options have their own advantages and disadvantages, and you should select the one that suits your investment goal, risk profile, time horizon, and tax status. You can also switch between the options, subject to exit load and tax implications. However, before you make any investment decision, you should consult your financial advisor and do your own research.

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