Investment funds are classified primarily based on their unique attributes and characteristics, such as fund size, asset allocation, investment objective, etc. Investors with high risk tolerance invest in investment funds that invest primarily in equity and equity-related instruments. These investors do not want to settle for low returns and are therefore at additional risk in the hope of great rewards. But the stock markets are volatile by nature, and if you invest beyond your limits, you could end up losing your starting amount.
Usually when it comes to making gradual and phased investments in mutual funds, experts recommend opting for a systematic transfer or systematic investment plans. But for those who invest significantly in debt funds and want a combination of equity schemes in their portfolios, there is one more option to invest at a staggered rate. It’s called a dividend transfer plan. Most fund houses offer dividend transfer plans.
First, invest a lump sum in a debt fund. Choose the dividend payment option. Preferably, choose the monthly or quarterly option, as that way the dividend payments from your debt fund are a little more regular and your investments in the chosen capital fund. You can also choose an arbitration fund as the source scheme.
At the same time, choose the fund in which you want to reinvest your dividend earnings, preferably a capital scheme. Since the dividend transfer plan (DTP) only works if you choose the source and destination schemes of the same fund house, your form should mention both schemes. The target scheme can be a well-diversified multi-layer capitalization fund with a good track record. The source scheme declares dividends when the value of the net asset appreciates. These dividends are invested in a capital fund. An investor’s capital is isolated since the funds are parked in a debt scheme.
Minimum dividend standard
Each mutual fund scheme comes with a minimum dividend payment amount of, say, 500 rupees. Anything less than that is not distributed. In such cases, DTP is not activated.
Be sure to put a minimum balance in your equity fund separately, when a DTP begins. All capital funds have a minimum investment threshold. Subsequent investments are generally allowed.
TDS on dividends
Since April 1, 2020, the tax on dividends paid by debt funds has been abolished. But dividends announced by mutual fund schemes are taxable in the hands of investors. Tax is deducted at source at a rate of 10 percent on dividends, when dividends exceed Rs 5000 in a financial year. Additionally, dividends are also taxable on your hands, based on your income tax brackets. Even if you have opted for DTP and your dividends declared in the debt fund are automatically reinvested in the equity fund, you still have to pay taxes on the declared dividends. TDS on dividends does not exempt you from your tax obligation.
Avoid risky debt funds for DTP
Since DTP’s goal is to protect your capital by investing in a debt fund, be sure to choose a scheme that invests in high-quality assets. If you choose a risky scheme and there is a downgrade, you may end up losing your equity in the debt fund.
Investors must set the right expectations when investing through DTP in a scenario of falling interest rates. As interest rates decrease, interest income, which is a major source of dividends, also decreases. DTP may work for conservative investors seeking capital protection, but they must understand that the amount and frequency are uncertain and, in that sense, their investments in capital funds will not be as disciplined as a systematic transfer plan or a plan of systematic investment.