Should Young Investors opt for the IDCW Payout Option in Mutual Funds?

There are two main options to choose when investing in mutual funds – the growth option and the Income Distribution Cum Capital Withdrawal (IDCW) payout option. In this article, we will look at the IDCW payout option, how it works, its pros and cons, and whether it is suitable for young investors.

• Table of contents

1. Understanding IDCW payout option
2. How does IDCW payout work?
3. Analysing the suitability for young investors
4. Pros and cons of IDCW payout option for young investors

Understanding IDCW payout option

The IDCW payout option in mutual funds schemes is a way for investors to potentially receive periodic income. When you choose this option, the mutual fund pays out its distributable surplus to you at intervals. These IDCWs can be paid out monthly, quarterly, or annually. However, the payout is not guaranteed, and the amount depends on the extent of distributable surplus available and is paid out at the discretion of the fund house.

When opt for IDCW, you can choose between IDCW payout and IDCW reinvestment. Under the payout option, you receive the IDCW payments as cash. Under the reinvestment option, the IDCW payments are used to purchase fresh units in the scheme.. This is different from the growth option, where the profits remain in the fund, increasing the value of your investment over time.

How does IDCW payout work?

Mutual funds offer the Income Distribution cum Capital Withdrawal (IDCW) to potentially give periodic payouts to investors. This payout can comprise income generated from the investments as well as capital gains.

• Income distribution: Mutual funds can generate income through dividends and interest. With IDCW, a portion of this income may be distributed to investors.
• Capital withdrawal: IDCW may also include giving a portion of the investor's capital as income.
• Effect on NAV: The mutual fund’s Net Asset Value (NAV) decreases with each IDCW payout.
• Suitability for investors: IDCW may suit investors seeking the potential for regular income, such as retirees. However, it can eat into the long-term growth potential because it reduces the amount of capital that gets market exposure.

Analysing the suitability for young investors

For young investors, deciding whether to opt for the mutual fund IDCW payout option depends on several factors. Young investors typically have a longer investment horizon and can afford to take more risks. They often aim for higher growth and wealth accumulation over time. Choosing the IDCW payout option might not align with these goals because the IDCWs paid out are not reinvested in the fund. This means that the potential for capital growth is lower compared to the growth option. Young investors might benefit more from the compounding effect of reinvesting profits, which can lead to significant growth over time.
To better understand how reinvesting profits through an SIP can enhance this compounding effect, using an SIP calculator can help illustrate the potential growth over your investment horizon. Another way to further optimise return potential is to opt for a step up SIP, where your SIP amount is increased by a fixed percentage at regular intervals. To explore how this plan can enhance your return potential when compared to regular SIPs, you can use an SIP step up calculator.

Pros and cons of IDCW payout option for young investors

Pros:

• Regular income: The primary advantage of the mutual fund IDCW payout option is the regular income it can potentially provide. This can be useful for young investors who need some cash flow for expenses. However, it is more commonly chosen by retirees or those looking for a supplementary stream of funds.
• Flexibility: Receiving IDCWs gives investors the flexibility to use the money as they see fit. They can reinvest it in other investments or use it for personal needs.

Cons:

• Reduced growth potential: The main disadvantage of the IDCW payout option is the reduced potential for capital growth. Because IDCWs are paid out instead of being reinvested, the investment may grow slower compared to the growth option.
• Tax implications: IDCWs received from mutual funds are subject to taxes. This can reduce the net returns for young investors, making the growth option more attractive from a tax perspective.
• Missed compounding benefits: Young investors miss out on the power of compounding when they opt for the IDCW payout option. Reinvesting IDCWs can significantly increase the investment's value over time, which is especially beneficial for long-term investors. A compound interest calculator or a lumpsum mutual fund calculator can help project how much your investment could potentially grow when IDCWs are reinvested to help you assess the significant difference in the return potential between IDCW payout and IDCW reinvestment.

Conclusion

While the mutual fund IDCW payout option provides regular income and flexibility, it may not be an ideal choice for young investors focused on long-term growth. The reduced growth potential and tax implications make the growth option more suitable for those looking to maximise their wealth creation over time. Young investors should carefully consider their financial goals and investment horizon before deciding on the IDCW payout option. 

FAQs

What is the IDCW payout option in mutual funds?

The IDCW payout option in mutual funds is where the fund pays out IDCWs to investors whenever it makes a profit, providing regular income.

How does the IDCW payout option differ from the growth option?

In the IDCW payout option, profits are paid out as IDCWs. In the growth option, profits are reinvested in the fund, increasing the value of the investment over time.

Are IDCWs a reliable source of income for young investors?

While IDCWs provide regular income, they may not be reliable for young investors focused on long-term growth due to reduced capital growth and tax implications.

What factors should young investors consider before opting for the IDCW payout?

Young investors should consider their financial goals, investment horizon, need for regular income, tax implications, and the potential for long-term growth before opting for the IDCW payout option.

How do taxes affect the IDCWs received from mutual funds?

IDCWs from mutual funds are subject to taxes, which can reduce the net returns for investors, making the growth option more attractive from a tax perspective.

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.