Dividend Yield Funds Can Enable Tax-Efficient Income Through Equities

The last few years have witnessed a rapid pick-up in equity investment culture in the country, which is evident through the growth in mutual fund Systematic Investments Plans (SIPs). Consider this, in January 2020, just before the Covid-19 pandemic struck, the investments coming into mutual funds through SIPs stood at around Rs 8,500 crore. This number has swelled to over Rs 13,800 crore in January 2023. The robust growth continues, and most of these flows are into equity mutual fund schemes.

Another reality faced by all participants in the markets is volatility. We have been in the midst of volatile market movements for a while now, which could continue for some more time due to multiple macro-economic factors. In such a situation, cash flow management and investment stability become a concern for many investors. 

Stability Through Dividends

The Nifty Dividend Index has now been around for over 15 years. When we look at the different instances of drawdowns in the market in this period, the results for the Nifty Dividend Opportunities 50 TRI have been encouraging. In terms of drawdowns, in 4 out of 5 major instances over the past 15 years, the dividend index fell less, in some cases slightly less, and in some cases significantly less than the overall market when the market corrected.
Similarly, Rs 1 lakh invested in Nifty Dividend Opportunities 50 TRI in January 2008 would have grown to Rs 5.74 lakh by January 2023, compared to Rs 4.20 lakh for the same amount invested in Nifty 500 TRI over the same period.

So, going forward, what is the strategy that investors should adopt to navigate through volatile market situations? One good option could be evaluating equity investing not only from the lens of capital appreciation but also for regular income.

Dividend From Equities – Why Choose The Mutual Fund Route?

Investing in equities to generate dividend income is a popular strategy around the world. What makes dividend yield funds attractive is the tax efficiency for the investor. As per the existing Indian tax laws, individuals' dividend income from equity investments is taxable at the marginal rate. It is also likely that sporadic dividend income is not put to productive use always and gets consumed. 

On the other hand, the income that comes from mutual fund schemes through dividends is not taxed similarly. The income from the scheme is not subject to tax, and the dividend proceeds in the scheme are invested in the same scheme, thereby adding more potential for future growth. 

So how does an individual optimize their cash flow through a dividend yield fund? There comes into the picture a Systematic Withdrawal Plan (SWP). Usually, SWPs are put to use to devise a tax-efficient way to gradually liquidate debt mutual fund holdings in the form of a regular cash flow. The less explored part is that SWPs can also be a viable tool to generate income from investments in equity schemes. Our back-testing has shown that investors investing in a dividend yield fund with an investment horizon of upwards of 5 years can also utilize the SWP facility to their advantage.

To be sure, being an equity scheme investing in a dividend yield fund is not a zero-risk strategy. Investors should ensure that the investments are in line with their risk appetite and investment horizon. However, once sure about a reasonably long investment horizon, using SWPs for withdrawals could result in an attractive, tax-efficient result. 

The author is the deputy managing director & chief business officer of SBI Mutual Fund
 

(Disclaimer: Views expressed are the author’s own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.)