IDCW vs Growth Options in Mutual Funds

The IDCW option provides investors with regular income in the form of dividends. The growth option of mutual funds focuses on capital appreciation and compounding impact for the investors. To explore more read this blog.
IDCW vs Growth Options in Mutual Funds
4 mins
23-April-2024

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.

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. 

 

IDCW Plan

Growth Pan

NAV of a mutual fund on 2nd May 2022

Rs. 30

Rs. 30

Investment amount

Rs. 30,000

Rs. 30,000

Units Allotted

1000

1000

NAV of a mutual fund on 1st April 2023

Rs. 40

Rs. 40

Dividend Declared

Rs. 10

Dividend Received

Rs. 10,000 = (1000*10)

Post Dividend NAV

Rs. 30 = (40-10)

Rs. 40

Units Issued Against Dividends

333.3 = (10,000/30)

Total Number of Units Held

666.6 = (1000 – 333.3)

NAV

Rs. 30

Rs. 40

Value of the Investment

Rs. 19,998

Rs. 40,000

 

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.

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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Frequently asked questions

Is it possible to switch from IDCW to a growth option?

Yes, it is possible to switch from IDCW to a growth option, but it may involve exit load and tax implications.

Can I convert IDCW to growth?

Certainly! Transitioning from the IDCW option to the Growth option is a straightforward process. Simply initiate a 'switch' transaction within the fund, facilitating the transfer of funds from the IDCW option to the Growth option.

Which is better dividend reinvestment or growth?

The choice between dividend reinvestment and growth depends on investors' preferences and financial goals. Dividend reinvestment offers compounded returns through reinvestment of dividends, while growth focuses solely on capital appreciation without regular income distributions.

What is growth vs IDCW in SIP?

Growth SIPs primarily accumulate capital appreciation, reinvesting returns to compound wealth over time. IDCW SIPs distribute regular income in addition to potential capital appreciation, providing investors with periodic payouts.

What are the benefits of IDCW?

IDCW offers investors a steady income stream through regular dividend payouts. It provides liquidity, flexibility, and convenience for investors seeking regular income from their investments. IDCW can serve as a source of passive income, especially for retirees or those needing periodic cash flows.

Which investment has the highest growth?

Investments with the highest growth potential typically involve higher risk, such as equities or emerging markets. However, individual investment performance depends on factors like market conditions, asset allocation, and investment strategy.

Which is better growth or income funds?

The choice between growth and income funds depends on investors' financial objectives and risk tolerance. Growth funds focus on capital appreciation, while income funds prioritise generating regular income through dividends or interest payments.

Should I invest in growth or value mutual funds?

Growth and value mutual funds represent different investment styles, with growth funds targeting companies expected to grow at an above-average rate and value funds focusing on undervalued stocks. Investors should consider their investment goals, risk tolerance, and market conditions when choosing between growth and value funds.

Is IDCW taxable in India?

Yes, IDCW (Income Distribution cum Capital Withdrawal) from mutual funds is taxable in India.

What is the tax rate for IDCW?

When the Income Distribution cum Capital Withdrawal (IDCW) exceeds Rs. 5,000 for an investor within a financial year, the fund house will withhold Tax Deducted at Source (TDS) at a rate of 10%. Consequently, the deducted TDS will be deposited into your income tax account and offset against the ultimate tax liability.

What are the disadvantages of growth mutual funds?

Growth mutual funds are subject to market volatility and fluctuations, potentially resulting in losses during downturns. They may carry higher risk compared to income or value funds, as they primarily focus on capital appreciation without providing regular income distributions. Growth funds may also be more tax inefficient, as capital gains are realized upon redemption, leading to tax implications for investors.

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