IDCW vs. growth option in mutual funds: Key Differences and which one to choose?

When applying for a mutual fund scheme, investors have to choose between the growth and IDCW (Income Distribution cum Capital Withdrawal) options. Understanding these terms and knowing the difference between them is essential so that you can choose an investment option that is suitable for your priorities and goals.

This article looks at IDCW vs. growth and simplifies both investment options so that you can identify which one would fit your financial plans.

• Table of contents

1. What is the growth option?
2. What is the IDCW option?
3. What are the differences between IDCW and growth options in mutual funds?
4. IDCW vs. growth: Which to choose
5. Is it possible to switch from the growth option to IDCW?

What is the growth option?

The growth option is a type of investment option where all earnings from your mutual fund investment (including capital gains and dividends) stay invested in the fund, increasing the value of your investment.

In simple terms, you won’t receive any regular payouts from the fund. Instead, your money stays in the scheme, increasing its Net Asset Value whenever the value of the underlying securities rises. The growth option retains your entire investment value in the fund until you redeem it. This allows your entire investment value to benefit from opportunities for compounded growth, which can result in significant wealth-building potential in the long term.

Here are some of the key features of the growth option:

• Compounding effect: Because all profits stay invested, your investment can potentially benefit optimally from compounding, resulting in higher growth potential.
• Higher NAV: The NAV of the growth option is usually higher than that of the IDCW option because all earnings stay invested.
• No regular income: You won't receive any payouts, making this option suitable if you don’t need regular income and your goal is to potentially build wealth over time.

What is the IDCW option?

IDCW stands for Income Distribution cum Capital Withdrawal. When you choose the IDCW option, the mutual fund may routinely give out a part of its distributable surplus to investors. The payout is called "Income Distribution plus Capital Withdrawal" because the amount released as income can include dividends and booked profits, as well as a portion of the invested capital.

When the fund pays out this income, the NAV of your investment reduces by the same amount and to the extent of statutory levy, if any. This means that while you receive some cash in hand, the value of your remaining investment decreases. Within IDCW, there are two options:

• IDCW payout: In this option, the earnings generated by the mutual fund are paid out to you in cash, meaning the IDCW amount is deposited directly into your bank account. This choice is suitable for investors who want the potential to generate an income stream from their investments.
• IDCW reinvestment: Instead of receiving the IDCW amount as cash, the income is reinvested to buy more units of the mutual fund. The reinvested units can potentially grow and earn returns in the future. This option is beneficial for those looking to increase the number of units in the fund without actively adding more money.

It is important to note that income from IDCW is not guaranteed and depends on scheme performance and the fund manager’s discretion and subject to approvals as prescribed in the Regulations.

Here are some notable features of the IDCW option:

• Potential for frequent income: If you need regular cash flow from your investments, IDCW can be suitable.
• Lower NAV: The NAV of the IDCW option is generally lower than that of the growth option. This is because the regular payouts reduce the value of your investment.
• Payouts not fixed or guaranteed: The amount and frequency of payouts depend on the fund’s performance and are not guaranteed.
• Taxation: Dividends stemming from investments are taxable in the hands of the investor. The dividend amount is added to an investor’s annual income and taxed at as per the prevailing tax slab.

What are the differences between IDCW and growth options in mutual funds?

Understanding the differences between IDCW and growth options is crucial for making an informed decision. Here’s a quick comparison:

Feature	Growth Option	IDCW Option
Profit reinvestment	All profits are reinvested, leading to compounding growth.	Distributable surplus is released to investors as income. They can then either be reinvested or can be received as cash.
NAV	Typically higher, as the value of the assets rises.	Typically lower, because payouts reduce the value of the investment.
Income distribution	No regular income, benefits are realised only when you sell the units.	Routine income payouts, but not guaranteed.
Suited for	Investors focused on long-term growth and compounding.	Investors needing regular income or cash flow.
Tax implications	Capital gains tax is applicable only when units are sold.	IDWC payouts are subject to tax once released to the investor. Additionally, capital gains tax will be levied as applicable upon redemption of units.
Return potential	Can be higher in the long-term because the entire investment value gets the opportunity to grow.	Can be relatively lower if income is routinely removed from the fund and credited to the investor.

IDCW vs. growth: Which one to choose

Choosing between IDCW and growth options depends on your financial goals and needs.

Here are some factors to consider:

1. Investment objective:
   • If your goal is to potentially build wealth over time, the growth option might be more suitable because it takes optimal advantage of the power of compounding in the long term.
   • If you need an income stream, IDCW may be more suitable.
2. Tax considerations:
   • With the growth option, you only pay tax on the capital gains when you sell your investment, which can be more tax-efficient in the long run.
   • IDCW payouts are taxable in the hands of the investor and are taxed as per the investor’s prevailing tax slab.
3. Risk tolerance:
   • The growth option may be more suitable for those who can tolerate market fluctuations and are focused on long-term growth.
   • The IDCW option is suitable for investors seeking to mitigate risk by routinely booking profits and receiving some income from their investments, even if it means potentially lower returns in the long term.
4. Financial needs:
   • If you don’t need regular income and can let your investment grow, the growth option may be more suitable.
   • If you require regular payouts for expenses, the IDCW option could be the right fit.

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

Yes, it is possible to switch from the growth option to the IDCW option, and vice versa. However, there are some things you should keep in mind:

1. Tax implications: Switching from growth to IDCW or vice versa is considered a sale of units, which may require you to pay capital gains tax.
2. Fees: The sale transaction may also attract an exit load. The amount and the investment duration for which an exit load is levied can differ from one fund house to another.
3. Timing: Switching isn’t something that should be done frequently. Evaluate your financial goals and needs carefully before making the switch to avoid unnecessary costs and taxes.
4. Financial objective: The choice to switch must be based on your financial strategy. For instance, if you do not need a secondary income stream and have a long investment horizon, the growth option may be better suited to your goals, even if the potential to receive regular payouts may seem appealing.

Conclusion

To sum up, both IDCW and growth options in mutual funds have their own advantages and drawbacks. The choice between the two depends on your financial goals, tax considerations, and need for regular income. The growth option can be suitable for those focused on long-term wealth creation and who can let their investment grow over time. On the other hand, the IDCW option might be better for those who seek the potential for regular income. Understanding these concepts will help you make an informed decision that aligns with your investment goals. Remember, there's no one-size-fits-all answer. It's all about what works best for your specific financial situation.

FAQ

Are there any tax implications with IDCW and growth options?

Yes, there are. In the growth option, you only pay capital gains tax when you sell your units. However, in the IDCW option, the payouts you receive are taxable in your hands.

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

Yes, you can switch from IDCW to the growth option. However, be aware that this is considered a sale of units and will trigger a capital gains tax. Additionally, some funds may charge a fee or an exit load.

How do the returns differ between growth and IDCW options?

In the growth option, returns are reinvested into the fund, leading to higher potential long-term growth due to compounding. On the other hand, IDCW provides regular payouts, but the overall returns might be lower due to a reduction in the investment base after a payout.

Who should opt for the IDCW option?

The IDCW option is suitable for investors who need the potential regular income from their investments, such as retired individuals or those seeking a second income stream. However, if you don't need regular payouts and are seeking to build wealth in the long term, the growth option may be more suitable.

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 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.