Investing in mutual funds offers a plethora of choices and the selection of the right option hinges on your financial goals and risk appetite. Among the critical decisions you’ll face lies the choice between the growth option and the dividend option. When investing in mutual funds in India, most mutual fund schemes provide two choices when it comes to how you receive your returns: growth option and dividend option.
Each option offers a different strategy for handling profits made by the fund, and the best choice for you will depend on your individual financial goals and circumstances. SEBI vide its circular number SEBI/HO/IMD/DF3/CIR/P/2020/194 has renamed the dividend option in mutual funds as Income Distribution Cum Withdrawal (IDCW) option. But what exactly sets these two apart? Let’s delve into their key differences.
Profit distribution
Growth option: This option reinvests all profits generated by the mutual fund scheme back into the scheme. These profits include both income received from investments and capital gains. This continuous reinvestment fuels the power of compounding, leading to potentially higher returns in the long run.
IDCW option: As the name suggests, IDCW schemes distribute a portion of the fund’s profits to investors at regular intervals. There are three sub-options within the IDCW option, which are:
IDCW payout:
- Dividends declared by the fund are paid directly to your bank account.
- Provides a regular income stream for expenses or reinvestment elsewhere.
- Dividends are taxable as income in the year they are received.
IDCW reinvestment:
- Dividends are automatically reinvested to purchase additional units of the same fund.
- Compounds return and grow your investment over time.
- No immediate tax liability on dividends, but capital gains tax applies when units are sold.
IDCW transfer:
- Dividends are transferred to another mutual fund scheme.
- Allows for flexibility in managing income and investments.
Individuals looking for a regular income stream should ideally select an IDCW reinvestment plan.
NAV impact
Growth option: The NAV (Net Asset Value) of a growth fund grows steadily over time due to the compounding effect of reinvested profits. This translates to a higher overall corpus value at the time of redemption.
IDCW option: With regular profit distributions, the NAV of an IDCW fund may experience dips after each payout. However, the reinvested portion continues to compound, potentially mitigating the impact of these dips over the long term.
Tax implications
Growth option: Capital gains made in a growth option are taxed only at the time of redemption, based on the holding period (long-term or short-term). This translates to tax efficiency compared to IDCW.
IDCW option: Dividends distributed under the IDCW option are taxed as income according to the investor’s tax bracket. Reinvested profits also get taxed based on the applicable tax bracket. This may lead to a higher tax burden compared to the growth option.
Suitability for Investors
Growth option: This option is ideal for investors with a long-term investment horizon (5+ years) and a focus on capital appreciation. They are willing to forego immediate income for potentially higher returns in the future.
IDCW option: This option caters to investors seeking regular income from their investments along with capital appreciation. It suits individuals with shorter investment horizons or those requiring a steady income stream for their living expenses.
Pros and cons of investing IDCW plan
The beauty of IDCW lies in its versatility:
Regular income: It provides a steady stream of income, ideal for retirees, investors seeking monthly payouts, or those with short-term financial needs.
Capital preservation: By gradually withdrawing a portion of your capital, you mitigate risk and build a safety net, especially crucial in volatile markets.
Compounding benefits: The remaining investment continues to grow through reinvestment and market appreciation, offering long-term wealth creation potential.
Of course, no financial instrument is a magic wand, and IDCW comes with its considerations:
Tax implications: Dividends are considered income and taxed according to your tax bracket. The capital withdrawal also reduces your cost base, affecting capital gains tax calculation when you eventually sell your units.
Lower NAV growth: Compared to pure growth options, IDCW’s NAV growth may be slower due to capital withdrawals.
Dependence on fund performance: IDCW payouts aren’t guaranteed and depend on the fund’s performance, market conditions, and the fund manager’s decision.
IDCW suited for whom?
It depends! Assess your individual needs and goals:
Long-term wealth creation: Prioritise growth options.
Regular income: Consider IDCW or dividend options.
Capital preservation: IDCW can be suitable, but also explore fixed-income instruments.
Consult a financial advisor for personalised guidance and choose the option that aligns with your risk profile and financial aspirations.
In conclusion, ultimately, the choice between the growth option and the IDCW option depends on your individual financial goals, risk tolerance, and investment horizon. Carefully weigh the pros and cons of each option and seek professional guidance if needed. By making an informed decision, you can navigate the world of mutual funds with confidence and unlock your financial potential.
Note: This is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.
Kuvera is a free direct mutual fund investing platform.
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Published: 29 Dec 2023, 10:35 AM IST