IDCW (Income Distribution cum Capital Withdrawal) is an option within a mutual fund that enables an income distribution to the investors at intervals determined by the distributable surplus of the fund. The amount of distribution under IDCW will not be fixed, but rather dependent on the performance of the fund.
In the event of an IDCW payout, the NAV of the mutual fund is likely to reduce by the same amount of payout, assuming market dynamics and taxes are not considered. It is clear that IDCW cannot be considered as additional income.
Investors have an option to select between IDCW Payout and IDCW Reinvestment according to the individual schemes. While IDCW Payout makes a distribution to the investor in form of cash, IDCW Reinvestment option utilizes the declared amount in purchasing units.
To investors interested in wealth creation, IDCW is sometimes compared with the Growth option because the income is reinvested in the fund. This will all depend on what is required of the investor.
What is IDCW in Mutual Funds?
IDCW refers to a scheme of mutual funds where some of the gains earned by the mutual fund scheme are paid out to the investors periodically without getting ploughed back into the scheme.
The name IDCW came into effect due to the decision made by SEBI (Securities and Exchange Board of India) in April 2021 and replaced the previous “Dividend Option.”
It was not just another renaming done by SEBI because, through this, the regulators were trying to rectify the common misunderstanding that prevailed among the investors regarding dividend payment.
The common mistake that people made due to the name “dividend” was thinking that the mutual fund companies pay extra money to the investors like the companies give dividends. However, mutual funds do not have any extra money to pay out, and the amount of dividend paid comes from the Net Asset Value (NAV) of the scheme, i.e., what the investor invests.
Hence, the name IDCW clears everything and makes it clear that the payout made by the mutual fund scheme is a combination of:
- Income Distribution – income earned by the fund as dividends from stocks, interest from bonds or from the sale of securities in the fund’s portfolio.
- Capital Withdrawal – a withdrawal of some part of investor’s own capital.
Why “Dividend” is Changed to IDCW?
Prior to this, there was liberal usage of the term ‘dividend’ in mutual fund houses, which led to three common misconceptions:
Misconception #1 – investors thought dividend was additional income beyond their invested amount, just like in case of fixed deposits.
Misconception #2 – many felt that the fund was earning higher returns on account of the dividend, while in actuality the net asset value falls by the amount of dividend declared.
Misconception #3 – investors thought dividend payouts were assured or fixed, while it is completely dependent upon the availability of surplus in the fund at the time.
By renaming it to IDCW, SEBI hoped to clarify the process of distribution itself within the very name of the scheme. This is a retroactive process and when you check your Consolidated Account Statement (CAS), you will find your old dividend schemes renamed as IDCW.
IDCW – An Illustrative Example
To explain this in detail, we take a simple example:
Consider an investor who has invested 1,000 units of a mutual fund scheme whose current NAV is Rs. 100 per unit. That means the investment value is Rs. 1,00,000.
Now, if the scheme gives out an IDCW of Rs. 5 per unit to the investor, he gets:
IDCW Total Value = Number of Units × IDCW Per Unit = 1,000 × 5 = Rs. 5,000
But once the IDCW is given, the NAV of the scheme falls to Rs. 95 per unit (i.e., Rs. 100 − Rs. 5). The new investment value for the investor becomes:
1,000 units × Rs. 95 = Rs. 95,000
If we add the Rs. 5,000 which has been distributed, then the value remains Rs. 1,00,000, same as the previous value. The investor has received no additional wealth but just the wealth he had earlier, which has shifted from his fund investment to his bank account.
This is exactly what SEBI wished to make clear to the investors, i.e., the IDCW distribution is not some kind of a bonus.
Types of IDCW Options in Mutual Funds
In case you are investing in schemes that offer IDCW, you get to pick between the following two sub-options:
- IDCW Payout Option
Under this option, each time the fund declares distribution, the amount gets transferred directly into your registered bank account. The option is ideal for those investors who would like a regular income from their investments in mutual funds, such as retired investors.
- IDCW Reinvestment Option
Under this option, instead of transferring the money into your bank account, the amount gets utilized for buying additional units of the same scheme, using the current NAV. Essentially, your value of investment does not change, but instead, you are left with additional units of the scheme. The option is beneficial to those investors who do not require a steady flow of income but would like the payout amount to remain invested, indirectly earning through compounding.
It should be noted that some fund houses even give you a third option, which is known as IDCW Transfer, wherein the amount gets automatically transferred to invest in another scheme of the same fund house.
Who should go for IDCW?
IDCW mutual funds could be appropriate for investors who would like to receive regular cash payments from their investments in mutual funds, as opposed to deriving cash flows solely through unit sales. Please note that IDCW payouts are not guaranteed and cannot be seen as assured/regular income.
Please think about IDCW if:
- You require periodic cash flows: IDCW could be suitable for those investors who seek to derive some cash flow regularly.
- You are close to achieving your financial goal: If you are getting closer to achieving your objective such as retirement, etc., then IDCW may be a good choice for you.
- You want some flexibility: IDCW provides liquidity to the investor without necessitating the investor to sell units each time he/she wants to derive cash flows.
- You are aware that the payouts are not assured: IDWC will depend on the distributable surplus of the fund and the policy of the fund, and hence it cannot be equated to the interest earned on an FD.
- You have a right investment strategy: IDWC may be suitable if periodic cash payouts suit your overall financial plan.
Benefits of IDCW
Periodic Income Generation
IDCW benefits for retired individuals, homemakers, or anyone else who wants regular cash flow without withdrawing the entire amount as income include the possibility of earning income through IDWC in monthly, quarterly, or annual installments.
Liquidity without Redeeming the Entire Investment
Through IDWC, the investor has the opportunity to draw down only portions of his/her investment in small amounts at a time and keep the remaining portion invested in order not to affect the future financial plan of the individual.
Transparency in the Source of the Distributed Amount
Following the mandatory guidelines by SEBI, fund companies now have to specify whether the distributed amount is from the earned income or capital gains. The division in this way is shown in the statement and provides greater clarity.
Additional Opportunity to Invest More
Through IDWC, an investor who does not require income distribution can have additional unit allocation in the portfolio.
Helpful in Turbulent Financial Markets
In some instances, certain investors find it more desirable to earn profits on a periodic basis by receiving payments from IDCWs even during periods when the markets are volatile.
Conclusion
IDCW or Income Distribution cum Capital Withdrawal is effectively the modern form of what was once known as the “Dividend Option” in Mutual Funds. The IDCW provides investors with periodic withdrawals from the Income and Capital of the fund and thus gives investors an option to have regular cash flow, if necessary. It is important, however, to know that these withdrawals are taken from your investment value and are not additional profits.
It is important to assess your goals and tax brackets prior to choosing IDCW over the Growth Option. If income is more important for you than the compounding, then IDCW may prove to be the right investment choice. On the other hand, if you are concerned with growth rather than income, Growth Option will likely be more suitable for you.
As with any other type of investment, you should either consult a financial advisor or conduct some research on your own.
