How do mutual funds distribute dividends to investors?

Dividends are payments (made out of profits) made by companies to their shareholders.

In case of stocks
If you invest in an equity stock directly, the dividends would get directly transferred to your bank account. Also, the bonus issues would get transferred to your demat account.

In case of mutual funds
An equity-oriented mutual fund may occasionally receive dividends and bonus issues from the underlying companies in which it has invested.

Unlike the case of stocks, the dividend received by the fund house is in cash. It is not paid to your bank account. As a result of the dividend payments and bonus issues, the AUM of the fund increases which in turn increases the fund's NAV. The fund may utilise this to find the best investment opportunity in the Growth plan. (Learn more about growth and IDCW mutual fund plans).

But when it comes to the IDCW plan, investors are often confused as to whether this is utilised to pay out dividends. In the IDCW plan, a portion of the fund's profit is used to distribute the dividends - this may or may not include the dividends received from the underlying companies/holdings.

Just like the Growth plan, the fund may choose to further invest the dividend amount. Moreover, it is not necessary for the fund to pay out dividends exactly when it receives from the stocks in its portfolio. It may or may not distribute the dividends at that point in time.

Suggested watch: Are dividend reinvestment plans of mutual funds good?