When browsing through various mutual funds schemes, you’ll often come across two options: Growth and IDCW (Income Distribution Cum Capital Withdrawal). With the growth option, any profits stay invested, which ultimately helps your money grow through compounding.
On the other hand, the IDCW option gives you regular payouts, which can be useful if you need a stream of passive income. But these payouts also reduce the fund’s NAV over time. In this IDCW vs growth matchup, both options have their own sets of pros and cons. Understanding what is growth and IDCW, the difference between IDCW and growth options, and their taxation will help you choose between the two.
What is the Growth Option in Mutual Funds?
Whenever you see the word growth next to a mutual fund scheme, it indicates that the profits it earns are reinvested instead of being paid out to investors. This allows the fund’s assets to grow over time, which increases its NAV (Net Asset Value). The aim is to take advantage of the compounding effect, where reinvested earnings generate further returns, which leads to long-term wealth creation. This option is thus best suited for investors who don’t need regular payouts and are focused on maximising capital growth over time.
Benefits and Features of the Growth Option
- The profits earned by the fund through dividends and capital appreciation are reinvested for long-term growth instead of being paid out as regular income.
- This increases the fund’s NAV over time, ultimately helping investors earn higher returns due to compound interest.
- This option is generally chosen by long-term investors.
- Since no regular income is paid out, these funds are taxed only when their units are redeemed or sold. The capital gains tax levied depends on the fund’s asset allocation and the investment’s holding period.
Before we go into direct IDCW vs direct growth plans, let’s first understand what the IDCW option means.
What is the IDCW (Income Distribution Cum Capital Withdrawal) Option?
IDCW stands for Income Distribution Cum Capital Withdrawal. As the name suggests, this option provides regular payouts to investors. After the payout, which may be monthly, quarterly, annual, and so on, the NAV of the fund drops. This option was previously called the dividend plan, but in 2021, SEBI changed its name for more transparency. The word ‘dividend’ was considered misleading as it led many investors to believe that these payouts were extra profits, like stock dividends. But that’s not the case. In reality, the payouts come from the fund’s earnings, which reduces the NAV after each distribution.
Benefits and Features of the IDCW Option
- Unlike growth funds, IDCW funds offer regular payouts to investors. This is the key difference between direct growth vs IDCW plans.
- The NAV of an IDCW fund drops after each payout. For example, if a fund has an NAV of Rs. 50 and announces an IDCW payout of Rs. 4 per unit, the NAV will reduce to Rs. 46 after the distribution. This is because the payout is made from the fund’s earnings.
- Due to this, the effect of compounding is reduced, making these funds not as suitable for long-term investors.
- Retired investors, however, can benefit from these funds as they need a regular stream of income. They can generate it without selling the units.
- Income earned from these funds is taxed twice – first when the fund distributes IDCW payouts, and second, when you sell or redeem your units. The capital gains are taxed according to the investment’s holding period and asset allocation, whereas the dividend payouts are added to your total income and taxed as per your tax slab.
- If the total dividend income exceeds Rs. 5,000 in a financial year, the mutual fund house deducts TDS at 10% before distributing the payout.
IDCW Example
Suppose an investor makes a Rs. 5,00,000 lump sum investment in an IDCW mutual fund with an NAV of Rs. 50. Thus number of units purchased: 5,00,000 / 50 = 10,000 units
The fund house declares dividends at Rs. 4 per unit. Total income received by the investor: 10,000 * 4 = Rs. 40,000. This amount is subject to TDS as it exceeds Rs. 5,000.
Also, the income is considered ‘Income From Other Sources’ so the tax liability on this amount is calculated as per the investor’s tax slab. If the investor falls under the 30% bracket, the burden can be significant. Income distribution impacts the NAV as well. After the payout, the NAV would drop by Rs. 4.
Difference Between IDCW and Growth in Mutual Fund
Here are some ways IDCW vs growth options in mutual funds differ from one another:
| Factor | Growth Option | IDCW Option |
| Meaning | Mutual funds offering growth options reinvest the fund’s earnings instead of paying them out to investors. | Funds with the IDCW option regularly distribute income in the form of dividends among their investors. |
| Taxation | Earnings are taxed only when the investment is redeemed or sold. | In addition to being taxed upon redemption, IDCW returns are also taxed at the time of distribution. |
| NAV | The NAV of growth option funds increases over time. | Payouts decrease the NAV of IDCW funds. |
| Regular Payouts | No regular payouts are offered by the growth funds. Profits can be claimed only upon redeeming units or selling investments. | IDCW funds offer regular payouts. |
| Compounding Effect | Since the fund’s earnings are reinvested, they also generate returns leading to a compounding effect. | Due to income distribution, the effect of compounding is lowered. |
| Investment Horizon and Suitability | Growth option funds are suitable for long-term investors as the effect of compounding helps create wealth over time. | Investors seeking a steady stream of income, like retirees, can opt for the IDCW option. |
As you can see, the key difference between IDCW and growth options is the treatment of returns. In the growth option, profits are reinvested, which allows the investment to grow over time through compounding. The IDCW option provides periodic payouts, but limited growth. A mutual fund investment planner can help you assess which of the two options will best suit your financial goals, needs, and risk tolerance.
Direct Growth vs IDCW: Which One Should You Choose?
If you’re mulling over whether to choose the IDCW vs growth fund, consider the following factors:
1. Financial Goals
For investors aiming to create long-term wealth, the growth option is the better choice. As profits are reinvested, the investment benefits from compounding, which leads to higher returns over a period. Investors looking to secure a regular income can opt for the IDCW option.
2. Risk Tolerance
Generally, growth option funds tend to be more volatile in the short term, however, their volatility also largely depends on their underlying asset class and investment strategy. For example, pure equity-based growth funds are more volatile due to market fluctuations, while hybrid growth funds tend to be more stable.
3. Tax Considerations
Growth option funds, especially equity-oriented growth funds, are considered more tax efficient, as they are only taxed on capital gains when redeemed. Moreover, LTCG up to Rs. 1.25 lakh per year is exempt, which contributes to higher tax savings.
In addition to capital gains tax upon redemption, the regular income from IDCW funds is taxed according to the investor’s income tax slab rates.
Example Scenario:
Let’s say Raj is starting out on his retirement planning journey. He could benefit from investing in an equity fund with a growth option because it’s an excellent tool to help him achieve his primary goal – long-term wealth creation. The returns generated by the fund (from capital appreciation and dividends received from stocks) will be reinvested, resulting in an increased NAV. As the fund does not need to distribute income to investors, the NAV will benefit from compounding and continue to grow.
Other Considerations
Once you’ve figured out which of the two options would be more suitable, analyse these factors before making your investment:
1. Consistency of returns –
Analyse the fund’s past returns over a 3, 5, and 7-year period to understand how well it has performed over different market cycles. Consistent performers are considered better compared to funds that show extreme highs but fail to sustain them.
2. AMC’s reputation –
Review the asset management company’s credibility, AUM, and investment philosophy before investing.
3. Fund manager’s expertise –
A well-experienced fund manager with a strong track record can make a big difference in returns, so understand how much success they’ve had managing different funds over the years.
4. Expense ratio –
AMCs charge an expense ratio to manage funds. A higher expense ratio can have a significant impact on returns, so it’s important to compare them across different schemes.
5. Risk-adjusted returns –
Key metrics like the Sharpe, Sortino, and Treynor ratios, along with alpha, beta, and standard deviation, help evaluate how well a fund performs relative to the risk it takes.
Searching through the mountain of options available can be a tough task, which is why you should also consider consulting with a mutual fund advisor before investing. An expert can guide you by analysing all the above factors, making personalised recommendations that maximise returns, minimise taxes, and help you realise your financial dreams.
Tax Implications of IDCW vs Growth
Another major growth and IDCW difference lies in how their returns are taxed.
1. Growth Funds Taxation
Profits from such funds are considered capital gains and are only taxed when the investment is sold or redeemed. LTCG on equity funds (where at least 65% of the portfolio consists of equities) is applicable when the investment is sold after being held for 1 year or more. In that case, a 12.5% tax is levied on gains, however, the first Rs. 1.25 capital gains are exempt from tax. If sold before a year, gains are subject to a 20% STCG with no exemption.
2. IDCW Funds Taxation
When redeemed, IDCW funds follow the same capital gains tax rules as growth funds. The payouts, however, are taxed differently. The income is considered ‘Income from Other Sources’, and is taxed in the hands of the investors according to their tax slab rates. So for investors in the 30% bracket, the tax liability can be substantial. On top of that, dividend income above Rs. 5,000 is subject to a 10% TDS before being credited to the investor’s account.
So as far as tax efficiency between growth vs IDCW options is concerned, the growth option, especially for long-term equity-oriented funds, comes out on top.
Switching Between IDCW and Growth: Is It Possible?
After understanding the difference between direct growth and IDCW options, you may be asking yourself, “Can I switch between them later?” The answer is yes, typically you can, through a process called switch transaction. But there may be certain conditions set by the AMC which you may need to check before doing so.
Even though you want to switch within the same scheme, recall a major growth and IDCW difference – the NAV. Both options will have different NAVs. When switching, you are basically redeeming units from one option and buying units in another. This will result in a capital gains tax, the rate depending on how long you’ve held the investment.
If the scheme has an exit load, it may also be charged and eat into your returns. This process allows investors to adapt to their changing financial goals, but before making a switch in your IDCW vs growth in mutual fund investment you should keep the tax and exit load implications in mind.
Conclusion: IDCW vs Growth – Which One is Better?
The difference between growth and IDCW in mutual fund investments lies mainly in how the fund’s earnings are used. The growth option is more suitable for individuals wanting to create wealth in the long term, while the IDCW option is geared towards investors looking to create a regular income. Factors such as financial goals, risk tolerance, investment horizon, and tax implications should be assessed before deciding between the two options.
The growth option is generally considered superior by many investors as it offers compounding and better tax efficiency. That doesn’t mean the IDCW option is without merits. Its limited growth potential makes it less attractive for long-term investors, but investors like retirees can find it useful compared to options like fixed deposits as it provides the market-linked returns along with periodic payouts.
