How Do Mutual Funds Pay Dividends?

Let’s look at a different aspect of the financial market except from buying and selling shares, this is mutual funds and dividends. So, have you ever wondered if you get extra cash back from your mutual fund investments? Many people think of this as a ‘dividend’ just like a small bonus for investing. 

But have you ever wondered, do mutual funds pay dividends? The answer is yes, but it’s not exactly what you might think. It’s not really “extra” money that you get, so understanding what happens to dividends in mutual funds is one of the most important things for an investor.

In this blog we will look upon how mutual funds pay dividends to the investors. 

What’s a Mutual Fund Dividend?

A mutual fund is like a big investment basket managed by a registered & professional fund manager. This basket makes money in a few ways:

• Company Profits: If your fund owns shares of a company like TCS, and TCS decides to share its profits, your fund gets a piece of that.
• Interest Earnings: If your fund has lent money (by buying bonds), it earns interest, just like a bank FD.
• Smart Selling: When the fund manager sells an investment for more than they paid, the fund makes a profit.

All this money gets collected in the fund. After paying its running costs, the leftover profit can be shared with you.

Read Also: What Is Dividend Yield? Definition, Formula, and Investment Insights

‘Dividend’ is Now Called ‘IDCW’

Here’s something every investor in India needs to know. In 2021, the market regulator and watchdog SEBI changed the name of the “Dividend Option” to IDCW which stands for Income Distribution cum Capital Withdrawal.

SEBI wanted to be crystal clear and protect the investors from being misled. The old name, “dividend,” made it sound like you were getting extra bonus money from your investments but this was not the whole story.   

• Income Distribution: This is the part that comes from the fund’s actual earnings.
• cum Capital Withdrawal: It means some of the money you’re getting is your own invested money being handed back to you.   

By this you can understand that IDWC isn’t a bonus just like a dividend. It’s the fund giving you a mix of its profits and a little bit of your own money back.

How do mutual funds pay dividends?

1. The fund gathers up all the profits it has made.
2. The fund manager looks at the pile of profits and decides if there’s enough to share.
3. If it’s a “yes,” the money is sent straight to your bank account. By law, it has to get to you within seven working days.   

Read Also: What is Dividend Policy?

What to Do with the Profits?

When you invest in mutual funds, you get to choose a path for your profits.

• IDCW Payout: Investors can get their cash directly and it lands in your linked bank account. This is best suitable for people who need a regular stream of money, like retirees.   
• IDCW Reinvestment: Instead of cash, the money is used to buy you more units in the fund. Here the investor does not cash out the profits rather get more funds in it.   
• Growth Option: This is the most popular choice as, no money is paid out, all the profits are ploughed back into the fund to help it grow bigger and faster making it more profitable and valuable over time.

Feature	IDCW (Dividend) Plan	Growth Plan
Profits	You either get cash or more units.	Money is put back into the fund to grow.
Price	Price of the units drop after the payout	Price of unit grows over time
Units	Stays the same or gets reinvested	Stays the same
Best suitable for	Someone who needs cash in hand regularly.	Someone who wants money to grow over the years.
Taxation	You pay tax on it in the year you receive it.	You only pay tax when you decide to sell your units

How are Dividend Pay Decided? 

The dividends in mutual funds are not 100% guaranteed, it’s not like a fixed deposit where you know exactly what returns you will be getting.   

The fund manager is the one who takes the decision after considering the following: 

• Profit Generated: A fund can only be distributed if there is enough profit generated.    
• Market Conditions: If the market is volatile and uncertain, then the manager might decide to hold onto the cash to be safe.
• Fund Basket: A fund that invests in big, steady companies might pay dividends more often than a fund that invests in exciting new startups.

How Dividends Affect Your Investment’s Value

When a fund pays you a dividend, the Net Asset Value (NAV) of your units drops by that exact amount. The NAV is just the price tag on one unit of your fund. Let’s walk through it. If you invest Rs.10,000 and the NAV is Rs.50, then you get 200 units (Rs.10,000 ÷ 50).

The fund declares a dividend of Rs.2 per unit, so with 200 units you get a total dividend payout of Rs.400 (200 × 2). At the same time, the NAV of the fund drops to Rs.48 (Rs.50 − Rs.2). The value of your current holding is now Rs.9,600 (Rs.48 × 200 units), and the cash received in your bank account is Rs.400.

There is no change in your total wealth because Rs.9,600 + Rs.400 = Rs.10,000. Essentially, the investment simply moves from one pocket (your mutual fund) to another (your bank account). This shows that the dividend is paid out from your investment value—it is not extra money.

Read Also: What is Dividend ETF?

How to Pick a Good Dividend Fund

If you’ve decided that getting regular cash is right for you, here are a few friendly tips for picking a fund:

• You should not just chase the biggest payout, as a fund that promises a huge dividend might sometimes be struggling. A very high payout can be a sign that the fund’s NAV has dropped.
• One should look for a steady track record where a fund that pays small but consistent dividends is often more reliable than one that’s all over the place.   
• Check the total return and don’t get fixated on the dividend rather look for the growth in the fund’s price plus the dividend.
• Your goals come first, if you’re young and saving for the long haul, the Growth option is almost always your best friend as it lets your money work for you. IDCW plans are generally best for people who are retired and need cash for their expenses.   

Conclusion

As we have read, we know that mutual funds pay dividends, which are now called IDCWs. The most important thing to remember is that this is not extra money. It’s just a part of your own investment being returned to you as cash. This is why the fund’s price (NAV) drops by the exact same amount.

Choosing between an IDCW plan (for cash payouts) and a Growth plan (to build wealth) is a personal decision. If you need regular income, IDCW can be useful. If you want your money to grow for the future, the Growth option is often the better path. The key is to understand how it works so you can make the best choice for your money.

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