Hard Truths of Dividend Income

Dividend Income: The Myth & The Math

Tarun had recently explored the stock market. After watching a few stock market videos and scrolling through Instagram reels, he was totally convinced to invest, not by the fundamentals, but by the ‘dividends.’

“Earn Passive Income Nearly Rs 50,000,” one YouTube video claimed. Another one claimed, “Buy these 5 stocks and earn dividends for life.” Tarun didn’t waste time and invested Rs 10 lakh directly into stocks known for dividends, public sector players, old-economy names and a few blue chips. As per his calculation, he would be earning Rs 50,000 annually with an average dividend yield of 5%, without even lifting a finger.

But the world works on realism.

Three quarters passed, the amount credited Rs 700 from x stock, Rs 240 from y stock and Rs 2,700 here and there. Some companies skipped dividends. Moreover, one of his stocks fell 20%, hurting his invested amount. Tarun felt cheated, but the market had not tricked him, his expectations had. Let’s learn from his story along with understanding the basics so we would not become investors like Tarun.

What is Dividend?

A dividend is a common practice of profitable companies to distribute a portion or whole of their profits with shareholders usually in the form of cash. This usually happens when companies do not find better avenues to reinvest their profits.

To measure the dividend payout, we use the formula of dividend yield. Remember, dividends are not paid on the current market price of stock, it is paid on the face value of a stock. For example, if a company declares a dividend of Rs 5 on the stock with a face value of Re 1 and the market price of stock is Rs 100, then the dividend yield will be 5%.

Dividends are usually paid quarterly or annually in the form of interim or final dividend; however it is not guaranteed that a company will pay the dividend every quarter. Also, not all companies pay dividends especially the growth-oriented and the ones who are not profitable.

Capital Gain Vs Dividend

When you invest in the stock market through mutual funds or direct stock picking, there are two outcomes viz. capital gain and dividends. The capital gain is the appreciation or increase on your money invested, whereas dividends are payouts. But it is the capital gain which makes you rich, which holds the power of compounding. It is exciting, rewarding when your investment climbs to 30%, 50% or doubles.

The dividends on the other hand look tempting but only have a short-term reward. They are a token of thanks for holding a stock, a little pocket money which is sometimes not even enough to reinvest in the same stock.

Now let's see an example of a famous dividend paying stock, Hindustan Unilever. In 2024, the company declared the total dividends of Rs 53 per stock including special and interim dividend. However, the stock price felt 12% from Rs 2,665 on 1 January 2024 to Rs 2,326 on 31 December 2024. Hence, it makes sense to focus on the potential of capital gain rather than dividends. Also, to generate a little amount of dividends you need to invest a huge amount in dividend yielding stocks, while compromising with the investment.

Taxation On Dividend

There was a time when this form of so-called passive income was tax-free in India, but this changed post 2020. As per the updated rule (FY 2024-25), dividends are fully taxed in the hands of investors.

● Tax Slab- Dividend income is added to your total income and taxed basis on your tax slab. This means if your income falls in the 30% tax slab, your dividend income will be taxed at 30%, if you are in 10% tax slab, the dividend income will be taxed accordingly.

● Tax Deducted at Source (TDS)- When you try to generate a significant income through dividends and the payouts exceed Rs 5,000 limit then there is TDS of 10% applicable on that. Although you can claim it in form 26AS while filing income tax returns.

Regular Income Via Dividend Or SWP?

Now before you get demotivated and your idea of generating passive income shatters, there is one alternative which is known as systematic withdrawal plan (SWP). This smart tool of passive investing is tax efficient, reliable and realistic to generate a regular income. So, let’s hurry!

● What is SWP- A systematic withdrawal plan (SWP) is a tool offered by mutual funds that allows the investors to withdraw a fixed amount at regular timeframe. You can set the withdrawal to monthly, quarterly or annually from your already invested big corpus. You can consider this as an opposite of Systematic Investment Plan (SIP) where you invest regularly.

● How SWP Works- So, let’s suppose your SWP corpus is Rs 10, and you decide to withdraw 6% to 8% annually: 6% = Rs 60,000/year or Rs 5,000/month A safe thumb rule is to withdraw 6% to 8% of your corpus annually. This range ensures longevity of corpus with market-aligned returns. To learn more about SWP withdrawal, you can use MINTIT SWP calculator and calculate with your own corpus.

● Tax Efficiency- SWP is tax efficient, there is a tax exemption of up to Rs 1.25 lakh if you hold equity funds for more than 1 year. While doing SWP, you’re selling a part of your investment, hence capital gains tax is applied. And the long-term tax capital gains tax on equity is 12.5% instead of 20% short-term capital gains tax if you redeem equity funds in less than a year.

Further, you can also use SWP smartly to pay home loan EMIs and other expenses. To learn more, please refer to MINTIT’s recent blogs on SWPs. MINTIT brings an educational library to teach you the fundamentals of wealth creation. Set SIPs, financial goals, avoid traps with professional advice and much more. MINTIT, India’s only dedicated Mutual Fund Platform which caters to your personalised goals and accompanies you to achieve your financial milestones is eager to help you build your wealth. Depending on your profile it can precisely suggest tailored investing plans to achieve your goals to generate a regular income.