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How to stop worrying about dividends and start living

During the bullish periods of the equity market, when dividend cheques were big and consistent, many investors put their hard-earned money into equity-oriented schemes to earn steady (and higher) income in the form of dividends.

What if we give you a choice to choose between two schemes D and G;

G, that gives you the flexibility to decide what you will take home each month and

D that leaves it to the whims and fancies of market performance.

It’s most likely you will opt for G, especially if you are looking for stability in the income stream. However, you might still have apprehensions as to the portfolio composition of both these funds and the risk it entails. 

What if we were to tell you that both these schemes maintain the same portfolio? Now, you might be wondering why on earth would anyone invest in ‘D’. 

That’s what we are trying to tell you through this article. ‘D’ represents the dividend option of an equity mutual fund scheme, while ‘G’ stands for the growth option.

However, if investor chooses a growth option, with a systematic withdrawal option (SWP), it will not only be tax-effective but also bring in the necessary stability in the income stream. How is that possible?

Changing times 

During the bullish periods of the equity market, when dividend cheques were big and consistent, many investors put their hard-earned money into equity-oriented schemes to earn steady (and higher) income in the form of dividends. However, with the equity performance facing headwinds due to market volatility, many funds have skipped dividends early this year, catching the investor off-guard. 

Moreover, with the introduction of 10% Dividend Distribution Tax (earlier it was nil) on equity-oriented schemes from April 1st 2018, dividend option lost its tax-free status. The dividend amount also reduced to that extent.

Investors need to realize that as per the SEBI norms, dividends can be declared only from the distributable profits of the fund and not from its capital. So, to that extent, dividends are susceptible to short-term NAV performance. 

Smarter alternative

However, if investor chooses a growth option, with a systematic withdrawal option (SWP), it will not only be tax-effective but also bring in the necessary stability in the income stream. How is that possible?

First of all, investors need to fix an amount as their monthly or quarterly income. Here, it is important to choose a rate of withdrawal that matches the expected rate of return from the fund.

So, for instance, if you have an investment portfolio of Rs 10 lakh and expect to earn 12% pa over the long-term, then opting for SWP of Rs 10,000 (Rs (10 lakh*0.12)/12) each month is a reasonable figure.

It is important that you remain invested for more than a year before triggering the SWP option. This is because gains made on units withdrawn after a year of holding will get taxed at a lower long-term capital gains (LTCG) tax rate of 10% (Otherwise, it is 15% short-term capital gains tax). While LTCG tax rate is similar to that of DDT, retail investors immensely benefit from the Rs 1 lakh exemption on LTCG that’s available for every financial year.

If you are invested already in the dividend option, check if there are any applicable exit loads on the fund before switching. Switching is as good as redemption from the taxation point of view. So, limit the damage by looking into the load structures.

Summing up

Living-off dividends after retirement is a dream shared by many. However, don’t depend on dividend option of equity-oriented schemes for creating a stable income stream. Instead, opt for growth option with a Systematic Withdrawal Plan – it will not only give you steady inflows but also save on taxes. So, stop worrying about dividends and start living.

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