When investing in a mutual fund scheme, you generally have two options: Growth Plan and IDCW Plan. The only difference between the IDCW Plan and Growth Plan's underlying portfolios, then, is how the gains generated by the scheme are applied to each plan.
Profits from the investment portfolio are reinvested in the mutual fund scheme under the growth option and thereby you benefit from compounding. As a result, the fund NAV increases as a result of the retained and reinvested gains. The growth in the NAV of the mutual fund schemes can be used to calculate the returns from the growth option. Growth funds have the potential for significant returns, as well as risk factors, stock volatility, tax efficiency, professional management, and diversification.
Important considerations for growth mutual funds:
Growth mutual funds typically have Net Asset Values (NAV) that are higher than the IDCW option. purely because profits are put back into the plan to generate compound returns.
Mutual funds for growth are only subject to tax when they are redeemed.
Short-term capital gains (less than 12 months) on investments in growth-oriented equity mutual funds are taxed at 15%. Long-term capital gains (greater than a year) are subject to a 10% tax. Any capital gains up to Rs. 1 lakh, however, are tax-free.
Short-term capital gains (less than 36 months) from growth-oriented debt mutual funds are taxed in accordance with your income tax bracket. Long-term capital gains are also subject to a 20% tax.
Income Distribution-Cum-Capital Withdrawal
A mutual fund's earnings are distributed to investors as dividends at predetermined intervals. The most typical distribution period for the majority of IDCWs (formerly known as dividend mutual funds) is once per year. Other programmes might also pay out on a daily, monthly, or quarterly basis.
Options under IDCW: -
1. Payout of income distribution-cum-capital withdrawal (IDCW) option
The mutual funds may give income to the unitholders based on the profits realised by the fund if the investor has investments in IDCW. As a result, investors may gauge returns by looking at the income they get and the growth in the fund's NAV (Net Asset Value). However, because the payout is dependent on a number of variables, such as the amount of available distributable surplus, realised profits, etc., such cash flows might not be recurrent income. But if you need recurring income flows from your mutual fund investments, you might want to think about choosing a systematic withdrawal plan (SWP). The investments are redeemed under the SWP at regular times, resulting in consistent cash flows to the investor.
2. Reinvestment of Income Distribution cum Capital Withdrawal (IDCW (Reinvestment))
In this scenario, the mutual fund's income distributions are reinvested back into the scheme. Additional mutual fund units are purchased using the IDCW (Reinvestment) amount at the current NAV. As a result, whether purchased through initial investment or reinvestment of Income Distribution or Capital Withdrawal, investors may gauge returns by the growth in NAV compared with the weighted average cost of the mutual fund units.
Since the income and gains from mutual fund schemes are reinvested in the fund itself, the growth and IDCW (Reinvestment) options may appear to be identical on the surface.
Important considerations for IDCW funds:
According to SEBI regulations, dividends may only be paid out from the corresponding mutual fund's profits.
With each distribution cycle, dividend payout rates may change.
Both equity and debt mutual fund dividends are taxed according to the investor's income tax bracket. An obligatory TDS is deducted at a rate of 10% from the entire dividend income if the investor has no other source of income. However, if the dividend distributed is Rs. 5000 or less, there is no deduction.
Do dividends announced by corporations and mutual funds differ in any way?
Although dividends released by mutual fund schemes (formerly known as IDCW) may appear or sound similar to dividends declared by companies, there are significant differences between the two:
Businesses distribute dividends using their profit after tax (PAT). Companies typically distribute dividends after holding back a portion of the profit for reserves and surplus accounts in preparation for future expansion. The management of the company determines how much of the profits should go to the reserve and surplus account and how much should be distributed as dividends to shareholders.
Mutual fund schemes can only pay dividends out of the total profits they have accrued. The dividend (IDCW) payment rate per unit is determined by the AMC. However, regardless of whether a scheme pays dividends or not, the accrued earnings belong to the investors and are recorded in the scheme's NAV (Net Asset Value).
After dividends are paid out, a scheme's Net Asset Value (NAV) will always decrease. After the dividend is paid, the NAV will decrease proportionately and be readjusted. In the example that follows, we will see that. In contrast, after dividends are issued, a company's share price may or may not decrease.
What are the misunderstandings in India regarding payouts from mutual funds?
1. The underlying equities in the plan portfolio pay dividends, not mutual funds.
The truth is that dividends paid by mutual fund schemes may also include dividends earned from the underlying stocks in the holdings of the scheme. The gains realised from selling equities included in the scheme portfolio may also be included.
2. Dividends from mutual funds are additional income on top of capital gains.
Dividends from mutual funds do not provide additional income or a return over the profit's investors receive upon redemption. Dividends from mutual funds are paid from investor capital and take the place of capital growth. Because of the dividends paid to investors, the NAV of the dividend plan decreases.
3. Mutual fund schemes' dividend options frequently book gains in order to pay dividends.
A mutual fund scheme's underlying portfolio for growth, dividend, or any other options is the same. The fund management records profits at the scheme level, which includes all options, whether they are growth, dividend, or other.
The difference is in how the scheme profits are distributed; if you choose the growth option, the profits are reinvested in the scheme and are reflected in the scheme's NAV; however, if you choose the dividend option (now known as IDCW), a portion of the profit may be distributed to investors at the fund manager's or AMC's discretion. Participants should be aware that the AMC is not required to distribute scheme profits to investors who chose the dividend option.
What to choose: Growth or IDCW?
In Growth Option, the scheme's earnings are still reinvested in the strategy. The investor can make money off of other investors' earnings if they invest for a long enough period of time. This, often known as the "power of compounding," can significantly contribute to an investor's ability to create wealth.
The fund manager / AMC has the option to transfer all or a portion of the scheme's profits to the investor in IDCW. Compounding is lost in the IDCW option since investors get IDCW payouts on a periodic basis.
If long-term wealth creation or capital appreciation are the investors' primary investment goals, they should invest in the mutual fund scheme's growth option.
If investors want consistent cash flows from their investments, they can choose the IDCW option, but they should be aware that there is no assurance of IDCW payouts in mutual funds and that the income distribution is entirely at the fund manager's or AMC's discretion.
Has a greater NAV since the value of the re-invested profit can grow over time.
Considering that dividend payouts are subtracted from the NAV, has a relatively lower NAV.
Re-invested into the scheme
Distributed to investors
The growth option prioritises generating long-term wealth, overall returns are higher than those of the dividend option.
The dividend option's eventual corpus will be less than the growth option's because investors get periodic payouts under this option.
Tax applicable only when units are redeemed.
Income from dividends is taxed at the investor's slab rate.