Some equity mutual funds earn dividends too; here’s why it may not be credited to your bank account — why it happens?

Equity mutual funds invest in shares of listed companies that may pay dividends to their shareholders. So, when a company in a mutual fund’s portfolio declares a dividend, the fund receives that dividend, but that does not necessarily mean the amount will be credited separately to investors’ bank accounts.

This is because of the type of mutual fund option you have chosen. When you are making an investment, you have to choose between a growth or dividend plan, which is also known as income distribution cum capital withdrawal (IDCW).

These two options represent different ways in which income generated by a mutual fund is distributed to investors. However, it’s important to know that not all mutual funds earn dividends.

Equity funds may receive dividends from stocks they hold (only if a company declares it), while debt funds earn interest or coupon income from their investments as they invest in bonds and other fixed-income securities.

When is dividend not credited as money?

When you are investing in stocks, dividends declared by some companies you hold are generally credited to your primary linked bank account. But the same process does not apply when you invest through a mutual fund’s growth plan.

Under the growth option, the returns generated by the mutual fund scheme are not distributed separately to investors but remain within the scheme.

This means that any dividends or interest income generated from the scheme’s underlying investments reflect in the scheme’s net asset value (NAV), which can increase the value of the investor’s holdings over time, depending on the performance of underlying securities.

How does a dividend MF plan work?

Dividend-paying mutual funds invest in income-generating assets like dividend stocks and REITs. These funds distribute a portion of their earnings to investors as dividends, usually on a quarterly or annual basis.

These payouts are based on the fund’s net income from interest and dividends received from the securities it holds. However, there’s a crucial caveat here: the dividend pay-out reduces the value of the investor’s investment in the fund.

The dividend plan was renamed as IDCW in April 2021, though the concept more or less remains the same. This plan is offered by asset management companies to investors who seek periodic income from mutual funds.

Which option is meant for you?

The primary difference between the growth and dividend options is how the returns generated by the fund are distributed to investors. While the growth option does not disburse cash but instead reinvest it in the fund, the dividend option can give you periodic income.

The growth option is generally preferred by investors who are focused on long-term wealth creation, as the returns remain invested in the scheme and can benefit from compounding over time.

The IDCW option may suit investors who want periodic cash payouts from their investments. A mutual fund may distribute a portion of its accumulated gains and capital to investors whenever a payout is declared, but it should not be viewed as gauranteed income or extra returns, according to a blog post by HDFC Bank.

Under the dividend option, the amount distributed as cash comes from the scheme’s assets, and the scheme’s NAV reduces by the amount paid out. Still, it can be considered by those seeking periodic cash flows, including retirees, depending on their financial needs.