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How IDCW payouts affect NAV in mutual funds

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Have you ever wondered how a mutual fund’s payouts to investors impact its Net Asset Value and thereby, your investment value? Understanding this concept is important to make informed decisions about your investments.

In this article, we’ll understand the relationship between Income Distribution cum Capital Withdrawal (IDCW) payouts and NAV in simple terms. If you’re new to investing or want to become a more strategic investor, we’ll help you to understand all you need to know about this topic.

  • Table of contents
  1. What does “dividend” mean in mutual funds?
  2. What effect do payouts have on Net Asset Value (NAV)?
  3. Example of NAV impact
  4. Do all the funds get dividends?
  5. Is a low NAV indicative of poor performance?
  6. Understanding return on investment
  7. Growth vs. reinvestment: Which is better?
  8. Benefits of reinvesting dividends and other payouts
  9. Mutual funds with growth
  10. Who should opt for IDCW payout?

What does “dividend” mean in mutual funds?

Dividends are payments made by a company to its shareholders, typically as a way of sharing its profits. In the context of mutual funds, however, the concept of dividends is more nuanced. The dividends received from underlying stocks in a mutual fund portfolio aren’t necessarily passed on to the investor. To understand this better, let’s look at concept of payouts in mutual funds.

When investing in a mutual fund, investors can choose between two plans: Growth and Income Distribution cum Capital Withdrawal (IDCW). The latter seeks to potentially provide investors regular income from their investment. However, this income is not guaranteed or scheduled and is paid out at the discretion of the fund manager.

IDCW was earlier called ‘dividend payout’, but SEBI mandated that the name be changed to provide more clarity to investors. Unlike dividends in stocks, mutual fund payouts are made from the fund's distributable corpus, which include capital gains, booked profits, interest or dividend income, etc. The term IDCW highlights that these payments are not additional earnings (like traditional stock dividends) but a portion of the portfolio value itself.

What effect do payouts have on Net Asset Value (NAV)?

Whenever a mutual fund makes IDCW payouts, the NAV decreases by the same amount as the payout. This reduction in NAV happens because the mutual fund is essentially distributing a portion of its assets to investors. Here's how

  • NAV (Net Asset Value) is the per-unit value of a mutual fund, calculated as: NAV = Total assets–Total liabilities/Number of units
  • It reflects the current market value of all the securities held by the fund.
  • When a fund declares an IDCW payout, it distributes a part of its assets to unit holders. This reduces the total assets in the fund, while the number of units remains unchanged.
  • Since NAV is calculated based on total assets, the NAV decreases proportionally to the amount distributed as IDCW.

This reduction only affects investors who have opted for IDCW. Those with the Growth plan do not see any impact of IDCW payouts on their NAV.

Example of NAV impact

If a mutual fund has an NAV of Rs. 100 and decides to release a payout of Rs. 10 per unit, the NAV will drop to Rs. 90 after the payout.

It’s important to note that this doesn’t mean that the fund is performing poorly, it just means that a portion of your investment is being released to you as income.

Do all the funds get dividends?

As explained, it is not dividends but a portion of the fund’s distributable surplus that may be released to investors. Investors get this income only if they opt for IDCW. Within IDCW too, there are two options: IDCW payout and IDCW reinvestment.

In the former, the IDCW is directly credited to the investor. In the latter, the income is used to buy more units of the same mutual fund. In other words, the IDCW amount is reinvested in the scheme.

Is a low NAV indicative of poor performance?

Not necessarily. A drop in NAV due to payout doesn’t indicate poor performance. It indicates that a portion of your investment value has been given to you as income.

Think of NAV as the current price of one unit of the mutual fund. Your investment has made gains if the current NAV is higher than the NAV at which you purchased units, and your investment has made losses if the NAV is below the purchase price. So, by itself, the per-unit value does not necessarily indicate performance.

Understanding return on investment

When considering the impact of payouts on your returns, look at the total return instead of just the NAV. Total return includes:

  1. Payouts
  2. Capital appreciation (growth in the fund’s NAV)

Example: Suppose you invested Rs. 1,000 in a fund. You received Rs. 100 as payout, and the NAV increased by another Rs. 200 owing to capital appreciation. Your total return would be Rs. 300.

However, choosing IDCW payout does reduce your growth potential over time. Had this money stayed invested, it would have continued to get market exposure and potentially benefit from compounded growth. So, that Rs 100 that you received as a payout could have potentially earned more returns and grown significantly over time.

Growth vs. reinvestment: Which is more suitable?

1. Growth option:

  • IDCW is not paid out; instead, profits are reinvested into the fund.
  • This leads to compounding, as your returns can earn additional returns over time.
  • Suitable for long-term investors looking to grow their wealth.

2. Reinvestment option:

  • IDCW payouts are reinvested to buy additional units of the fund.
  • This increases the number of units you own, potentially increasing return potential
  • However, these payouts are taxed as dividends at the hands of investors.

While growth and IDCW reinvestment offer similar return potential, the chief difference is that in Growth, value of your investment (reflected in the NAV) is higher while in IDCW reinvestment, the number of units you purchase keeps increasing.

Benefits of reinvesting IDCW payouts

Here are some benefits of IDCW reinvestment:

  • Can result in increased growth potential over time as all your money stays invested
  • Can take advantage of market fluctuations by buying more units during a dip.
  • Enhances the scope for compounding over time.

Mutual funds with growth

If you’re looking for mutual funds that focus on long-term wealth creation, the growth option or IDCW reinvestment may be suitable. Here’s how growth works:

  • Profits, income, dividends etc stay invested in the fund
  • This can increase the fund’s NAV over time.
  • This results in better long-term growth potential

Who should opt for IDCW payout?

1. Investors seeking regular income: It can be suitable for those who want income from investments, such as retired professionals or those seeking supplementary funds.

2. Short-term investors: Those looking for immediate gains may prefer IDCW payouts over waiting for long-term capital growth.

Conclusion

IDCW payouts in mutual funds play a significant role in how your investment grows and how the NAV behaves. Choosing between growth and IDCW options depends on your financial goals. If you seek income from your investments, IDCW can be beneficial. For long-term growth potential, the Growth plan or IDCW reinvestment may be more suitable. Understanding the impact of IDCW on the NAV can help you make informed decisions.

FAQs

What is NAV in mutual funds?

NAV, or Net Asset Value, is the price of one unit of a mutual fund. It reflects the fund’s total assets minus its liabilities, divided by the number of units.

How do IDCW impact the NAV of a mutual fund?

IDCW payouts reduce the NAV of a mutual fund by the exact amount of the dividend paid out. This happens because the payout comes from the fund’s assets.

Why does the NAV decrease after a IDCW payout?

When payouts are released, the fund’s assets decrease by the payout amount, causing the NAV to drop accordingly.

Does the overall value of my investment change after receiving an IDCW payout?

No, the total present value of your investment remains the same. The decrease in NAV is offset by the payout you receive. However, your long-term return potential typically reduces if you withdraw money from the fund rather than letting it stay invested and access growth opportunities in the market.

Are dividends in mutual funds taxable?

IDCW payouts are taxed as dividends in the hands of the investor as per their income tax slab rate. Be sure to account for this when planning your investments.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.

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