The securities and exchanges commission of India is responsible for the purview of everything that comes under the regulated investments in India. This includes mutual funds as well. Mutual funds, being one of the most popular market-linked investment options, have to be closely regulated to protect the interest of the investors. For, SEBI brings about changes to how the mutual funds function every now and then to best fit the current conditions. The introduction of IDCW is such a new age.
If you are a mutual fund subscriber, chances are you have already noticed this difference. But for the uninitiated, Income Distribution cum Capital Withdrawal is introduced to replace the ‘dividend option’ in mutual funds. But how does it work? How is it different from the dividend option? Read on to find out.
What is the change?
There are two main ways from which a mutual fund can earn income – through dividends and from the sale of underlying equities or other securities. The new IDCW is introduced as a regulation to this to brng more clarity.
The idea behind it is that SEBI wants to emphasise that this income comes from the investment value only. In other words, when you receive this income, it amounts to a withdrawal of capital. According to SEBI, this squashes some misconceptions that dividend scheme mutual funds had. But what were those misconceptions? Let us see.
Myth – Dividend pay from mutual funds accounts only for the income that comes from the underlying stocks.
Reality – The income includes both dividend payments and the income that comes from the selling of underlying shares. The term ‘dividend option’ may not accurately describe this, resulting in the above misconception.
Myth – Dividends from mutual funds are extra income that comes over and above the capital appreciation.
Reality – Dividend payments are actually a part of capital appreciation. It is not above and beyond the potential capital appreciation a fund has. If you were ever subscribed to a dividend option fund before, you might have noticed the fund’s NAV falling right after the dividend pays out. This is the reason for this fall.
Myth – Dividend option mutual funds book profit on a regular basis.
Reality – The working of a mutual fund, doesn’t matter whether it is growth or dividend options, is the same. The only difference here comes with how profits are distributed.
In the case of a growth option, the profits that are booked are reinvested in the fund. For instance, if your investment of Rs.1000 booked a profit of Rs.100, the same will get reinvested, and the compounded amount will start earning profit.
In the case of the dividend option (now IDCW), the fund gets distributed once the profit is booked. This helps investors garner regular income from the same.
Company dividend vs mutual fund dividend?
Even though the working of both dividends may sound similar, they are some differences.
Most importantly, companies pay only a portion of their profits as dividends. They make enough reserves that are needed for their operations before declaring the dividend.
At the same time, mutual fund companies can only pay dividends from the profit the fund has garnered, and they have to pay the same in full.
The dividend payment doesn’t affect the company’s stock price in any way. This is because the stock price is not linked to the profit the company has.
On the other hand, the NAV of an IDCW mutual fund always goes down after dividend payment. This is because, as said above, dividends are a part of the capital.
Although you may not realise any change, the change to IDCW is important as it enables you to understand more about the fund. Understanding in detail about the fund is necessary before investing.