Growth or IDWC Fund – What's the Right Choice for Long-Term Investors?

The terms Growth and IDCW often appear side by side on mutual fund statements, leaving investors wondering which to pick. While both options draw from the same underlying fund, their payout structures and compounding potential vary. Learning the Growth vs Dividend Mutual Fund debate is beneficial, especially for long-term investors looking to build wealth efficiently over time.

This article breaks down how these two options work, their key differences, and which might be suitable for you as a long-term investor.

Understanding the Basics: Growth vs Dividend Mutual Fund

When you invest in a mutual fund, you can usually select between two options: Growth or Dividend (now known as IDCW - Income Distribution cum Capital Withdrawal). In the Growth vs Dividend Mutual Fund context, the difference lies in how the profits made by the fund are handled.

• Growth Option: In this plan, any profits, interest, or dividends earned by the fund are reinvested back into the scheme. This means you don't receive payouts during the investment period, but your investment grows through the power of compounding.
• Dividend (IDCW) Option: Here, the fund periodically distributes part of its profits to investors as dividends. These payouts can be made monthly, quarterly, or annually, depending on the fund's performance and policy. The fund's Net Asset Value (NAV) drops to the extent of the dividend paid out.

Both options have the same portfolio but differ in how returns are realised and taxed.

How Growth Funds Work

In a Growth option, your returns accumulate within the fund. Over time, as profits and gains are reinvested, your NAV continues to rise. You benefit when you redeem your units by selling them at a higher price than you purchased them.

This approach suits investors who don't require regular income and prefer to let their investments grow undisturbed. Since the money remains invested, the compounding effect works strongly, making it beneficial for long-term wealth creation.

For example, if you decide to invest ₹1,00,000 in a mutual fund under the Growth option, and the fund earns 10% annually, your investment grows every year without any interim payouts. Over 10 years, this can compound, possibly leading to a larger corpus compared to receiving periodic dividends.

How Dividend (IDCW) Funds Work

In a Dividend or IDCW option, investors receive periodic payouts from the profits the fund makes. However, the frequency and amount of these dividends depend entirely on the availability of distributable surplus. It is important to note that dividends are not guaranteed and may vary over time.

When a dividend is paid, the NAV of the fund reduces accordingly. For instance, if your mutual fund's NAV is ₹50 and a ₹2 dividend is declared, the NAV falls to ₹48 after the payout.

This option can be suitable for investors who prefer regular cash flows, such as retirees or those seeking periodic income without redeeming their units.

The Difference Between Growth and Dividend Option in Mutual Funds

While both options invest in the same portfolio, the difference between Growth and Dividend options in mutual funds lies mainly in three areas: return pattern, taxation, and suitability.

Return Pattern:

• Growth: Returns are reflected in the rising NAV and realised when you redeem the units.
• Dividend(IDWC): Returns are paid out periodically, reducing the NAV with every distribution.

Taxation:

• In the Growth option, you pay capital gains tax only when you sell the units. Long-term capital gains are taxed is applicable beyond ₹1.25 lakh of annual gains (for equity funds).
• In the IDCW option, dividends are added to your annual income and will be taxed as per your applicable income tax slab.

Suitability:

• Growth: Better for long-term wealth creation and compounding.
• IWDC: Suitable for those seeking periodic income from their investments.

Understanding what are growth and dividend mutual fund options can help you align your choice with your financial goals and income needs.

Which Option Works Better for Long-Term Investors?

For long-term investors, the Growth option often proves more beneficial. Here's why:

• Power of Compounding: Since all earnings are reinvested, you earn returns on your past gains, allowing your corpus to grow exponentially over time.
• Tax Efficiency: In a Growth fund, you're taxed only when you sell, and not on yearly gains. This defers tax liability, helping your money stay invested longer.
• Capital Appreciation: Long-term investors benefit from market upswings, and the rising NAV can lead to higher total returns compared to receiving smaller, periodic dividends.
• Flexibility in Withdrawals: You can redeem units as needed, giving you control over how much you wish to withdraw, unlike dividends, which are irregular and fund dependent.

That said, the Growth vs Dividend Mutual Fund decision also depends on your individual situation.

When Dividend (IDCW) May Be a Better Option

While Growth funds are ideal for wealth accumulation, IDCW funds might be suitable if you need regular income, for instance:

• If you are retired or nearing retirement.
• If you rely on investment income to meet household expenses.
• If you prefer a conservative approach to realising returns.

In such cases, the dividend plan vs growth plan decision leans towards stability rather than capital growth. However, it's still important to remember that dividends are not assured, and income may fluctuate.

Making the Right Choice for Youself

There's no one-size-fits-all answer in the Growth vs Dividend Mutual Fund comparison. Your choice should depend on:

• Financial Goals: If your goal is long-term capital appreciation, such as saving for retirement, education, or a major purchase, you should look at different growth mutual funds.
• Cash Flow Needs: If you need regular income, IDCW can meet that need.
• Tax Bracket: Investors in higher tax slabs may find growth plans efficient, as dividends are taxed as regular income.
• Investment Horizon: The longer your horizon, the more compounding can work in your favour with growth funds.

Growth plans generally suit long-term investors who can stay invested without needing frequent payouts, while IDCW plans fit those preferring consistent, albeit variable, income streams.

Conclusion

Understanding the Growth vs Dividend Mutual Fund distinction is vital for aligning your investments with your financial objectives. For long-term wealth creation, assess your goals, tax position, and liquidity needs. Consulting a qualified financial advisor can also help you choose the most appropriate option for your investment journey. You can also deepen your understanding of fund strategies and long-term planning by exploring expert insights from Indiabulls Securities Limited (formerly known as Dhani Stocks Limited).

Disclaimer

Mutual fund investments are subject to market risks, read all scheme related documents carefully.

Refer to the Risk Disclosure Document to know the risks associated with F&O Trading.

FAQs

1. Are Growth and Dividend mutual funds separate schemes?

No. They are not separate schemes. Both options invest in the same underlying portfolio; only the way profits are distributed differs.

2. Can I switch from Growth to Dividend option later?

Yes, most mutual funds allow switching between Growth and Dividend (IDCW) options, though it may have tax implications or exit loads.

3. Are dividends from mutual funds guaranteed?

No. Dividends depend on the fund's performance and the availability of distributable surplus. Fund houses are not obligated to declare dividends regularly.

4. Which option gives better post-tax returns- Growth or Dividend?

Generally, Growth options offer better post-tax returns for investors in higher tax brackets since dividends are taxed as regular income, while capital gains in Growth funds are taxed only on redemption.