VR Logo

Dividends were never dividends

Mutual fund dividend plans have been renamed income distribution cum capital withdrawal plans, but that's not the real story

Dividends were never dividends

At the beginning of this financial year, SEBI changed one of the oldest pieces of nomenclature in Indian mutual funds: there is no such thing as a dividend any more. What used to be called a dividend is now simply called a distribution and what used to be called dividend plans of mutual fund schemes are now called 'Income Distribution cum Capital Withdrawal' plans. That's a mouthful so these will be called IDCW, which is also a mouthful but nothing can be done about that or should be done because the term is accurate.

It's accurate because in any real sense of the word, there were never any dividends paid in mutual funds. It was always an illusion. What was called dividend was always exactly what the new name says: Income Distribution cum Capital Withdrawal. However, it's quite clear that a lot of investors are still having some problems understanding what this whole business is all about and believe (are being misled) into thinking that the payout is actually a dividend and only the name has been changed. The reality is the opposite. It was never a dividend and the name has now been changed to the correct one.

Once upon a time (meaning till two months ago), dividends in mutual funds were well understood to be a sales-boosting trick. Not by investors, obviously, who were the target of this trick but by fund salespeople and distributors. When funds came out with dividends, salespeople showed that off to potential investors as evidence of it being a good fund. Over the years, SEBI cracked down on the source and accounting of the money that was distributed as dividend but the quality affirmation idea was still quietly promoted while making a sales pitch.

Let's understand what the dividend/IDCW is. Let's say you own a thousand units in a fund with an NAV of Rs 20. Your investment is worth Rs 20,000. The fund announces a dividend/IDCW of 20 per cent. That's 20 per cent of face value, which is Rs 10 or a payout amount per unit of Rs 2. For your thousand units, you'll get Rs 2,000. However, this amount will come straight from the value of your investment. On the record date, the NAV of the fund will drop by Rs 2 to Rs 18. This means that along with receiving Rs 2000 as dividend/IDCW, your investment will be worth Rs 2000 less.

There is no bonanza. You have gained nothing. Financially, it's exactly as if you have withdrawn that money from the fund. So getting a mutual fund dividend/IDCW is a zero-sum game. Dividends/IDCW have no impact on the return you are getting from your investment. There are no exceptions to this and there is no additional benefit at all. This payout just means taking some of the money that was already yours and giving it to you. Unless you need the income, there is no sense in picking the dividend option in an equity fund. In fact, even if you need the income, it is better to pick a non-dividend (growth) option and withdraw according to your own needs and schedule rather than according to the mutual fund's own logic.

It's unfortunate that this belief is so deep and it has lasted for so long. This renaming should have been done years, perhaps decades back. Certainly, the need for this renaming has been discussed publicly for a long time. Even now, it's quite clear that it will be some years before the term dividend is finally forgotten. However, now that the formal renaming is done, at least knowledgeable mutual fund investors should move out of the dividend illusion.