Should you rely on mutual fund dividends for regular income?

"When will my fund declare a dividend?" This question reveals one of the most common misconceptions in mutual fund investing. Many investors eagerly anticipate dividends as they would from stocks—an extra perk on top of returns. However, the reality is quite different.

Basically, you have two options if you want to invest in a mutual fund. In the Growth option, your returns remain invested, compounding over time for higher wealth accumulation. In the Dividend option (Income Distribution cum Capital Withdrawal or IDCW), you receive intermittent payouts as dividends.

The truth about mutual fund dividends

• Not an additional income: Mutual fund dividends are simply portions of your own investment being returned to you. It reduces your investment value and limits the benefit of compounding.
  When a dividend is declared, the fund's NAV (net asset value) decreases proportionately.
  For example, let's say you hold 1,000 units of a mutual fund with an NAV of Rs 100, totalling Rs 1,00,000. Now, the fund declares a dividend of Rs 5 per unit. You receive Rs 5,000, but the NAV drops to Rs 95 per unit. Your investment is now worth Rs 95,000 instead of Rs 1,00,000.
  While you receive cash, your overall wealth remains the same, except now you have a smaller compounding base for future growth.
  
• Discretionary distribution: Fund houses determine when and how much dividend to distribute. There is no reliable pattern or timeline, making them an unpredictable source of income.
  
• Taxation: An IDCW plan attracts unnecessary tax liabilities as the entire dividend amount is taxed at your income tax slab rate (which can be as high as 30 per cent). This makes it significantly less tax-efficient compared to growth plans, especially for equity funds where long-term capital gains are taxed at 12.5 per cent.

A better alternative for regular income

If your goal is to generate regular income from your mutual fund investments, a systematic withdrawal plan (SWP) is a smarter option than an IDCW plan:

• SWP allows you to withdraw a fixed amount at regular intervals while your remaining investment continues to grow.
  
• Unlike IDCW, where payouts are at the fund house's discretion, you control the timing and amount of withdrawals through SWP.
  
• SWP is more tax-efficient as you pay tax only on the capital gains portion of each withdrawal rather than on the entire amount.

Final thoughts

Instead of waiting for uncertain dividends, let compounding and tax efficiency work in your favour.

If you need regular income, a SWP from a growth plan of a mutual fund provides greater control, predictability and potential for long-term wealth creation.

Also read: The better option for regular income: NPS or equity savings funds?

This article was originally published on March 06, 2025.