In today’s Finshots, let’s take a look at the Indian Government’s dividend portfolio and understand whether such a portfolio would help you & me, as retail investors.

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The Story

Earlier this year, the Reserve Bank of India (RBI) handed the government a record surplus payout of ₹2.69 lakh crore. That’s 27% higher than last year’s transfer. (We even wrote about it in this edition of Finshots). A little while later, several public sector undertakings (PSUs) began announcing significant dividends to their shareholders.

These two events seem quite unrelated. So why are we talking about this now?

Well, these two events reveal something about how policymakers are thinking about money. More specifically, about how to raise money for the public exchequer without increasing debt or taxes (yes, you read that right).

And there’s one more clue that ties it all together. In the Union Budget 2025, the government quietly doubled the threshold for tax deducted at source (TDS) on dividend income from ₹5,000 to ₹10,000. That means retail investors can now receive a larger chunk of dividend income without the taxman automatically deducting a portion upfront. It ain't much, but it helps out people doing honest work.

But to understand the government’s thinking, it helps to look at what makes dividends so appealing in the first place.

First, dividends are immediate, visible, and bankable. Unlike capital gains, which occur only when you sell the shares, dividend income hits the bank without doing so. In a year when tax collections can wobble and disinvestment targets are missed, predictable cash from public enterprises is a policymaker’s comfort blanket.

Second, each extra rupee arriving via dividends is one less rupee the Centre must borrow. Lower borrowing shrinks the supply of fresh government securities, which can trim bond yields, reduce interest payments, and, in turn, free up room for spending.

Third, many mature public firms have large cash piles earning modest returns. Forcing those rupees back to the shareholder either funds the exchequer directly or signals that idling capital will no longer be tolerated. From a governance standpoint, that is progress.

This brings us to the question: if the government is relying more on dividends to shore up its finances, should you and I, as retail investors, be doing the same?

After all, dividends feel good. There’s a certain comfort in seeing actual rupees land in your bank account every quarter, especially when markets are volatile or just moving sideways. It’s money you can spend, reinvest, or simply use as reassurance that your investments are doing something productive. And with PSUs under pressure to increase their payouts, the yields on some of these stocks look more attractive on paper.

But here’s where it gets interesting. The textbook definition of a dividend is simple. When a company earns profits, it can either reinvest those profits back into the business or return a portion to shareholders in the form of dividends. Let’s say a company pays ₹10 as a dividend per share; the share price, in theory, should drop by ₹10 on the record date.

That’s because the company is handing over ₹10 of its cash to shareholders. This cash leaves the company’s books and, all else being equal, reduces the company’s net worth by the same amount. Since the value of a stock is ultimately tied to what the company owns and earns, the market adjusts the share price downward to reflect that outflow.

But if the business is healthy, generating good cash flows, and continues to grow, the market often shrugs off this short-term dip. In fact, the share price can recover fairly quickly, especially if the payout signals confidence in future earnings.

This is one reason why investors are drawn to dividend-paying companies in the first place. There’s a perception of stability, where the company is saying, “Hey, I’m rewarding you for holding this stock, and I’m confident that the company can grow even without this money.”

Sectors such as tobacco, utilities, or large-cap IT firms tend to be mature businesses with fewer opportunities for aggressive reinvestment. They generate steady cash and don’t need to plough it all back into expansion. So, instead of letting the cash pile up, they share the spoils with shareholders. And for investors looking for predictable income, that’s a pretty compelling proposition.

Even some of the world’s most respected investors, such as Warren Buffett, own large positions in dividend-paying giants. Coca-Cola, for instance, has been in Buffett’s portfolio for over three decades, consistently delivering dividends that have grown over time. 

But here’s the thing: Buffett doesn’t chase dividends. What he actually cares about is capital allocation. He wants companies to deploy capital in the most efficient way possible. The dividend itself is not the prize; it’s a byproduct of a business that’s run well. 

And this is exactly where we need to draw the line. Not all dividends are created equal. 

Sometimes, a high dividend yield isn’t a sign of strength. For instance, when a company’s earnings are stagnating or its stock price is falling, the dividend yield can look artificially high. Imagine a firm whose stock price has been cut in half, but the dividend hasn’t changed. Suddenly, the yield looks sky-high. But dig a little deeper and you might find the business is in decline, and the dividend isn’t sustainable. These are known as value traps. These are companies that lure you in with big payouts but offer little in terms of long-term growth.

Then, there’s the matter of taxes.

For retail investors in India, dividend income is added to your total income and taxed at your applicable slab rate. So, if you fall into the 30% bracket, a 5% dividend yield effectively becomes 3.5% after tax. And that’s before inflation takes another bite. Compare that to a company that reinvests profits at a decent growth rate or IRR (internal rate of return), and over time, that compounding often beats the upfront gratification of a taxed dividend.

This is why many advisors suggest viewing dividends as just one piece of the puzzle, not the entire picture. A good dividend stock should not only pay a decent yield but also have strong fundamentals: consistent free cash flow, healthy earnings, and a reasonable payout ratio. Ideally, the company should continue to reinvest a portion of its profits to fund future growth. If a firm is paying out 90% or more of its profits every year, that’s usually a red flag. It means there’s very little left to fuel expansion, pay off debt, or handle tough times.

That said, dividend investing isn’t a bad idea. It just needs to be done thoughtfully. 

If you’re someone who relies on investment income to cover monthly expenses, such as a retiree, a well-constructed dividend portfolio can be a predictable source of cash flow. And since your overall income may be lower in retirement, the tax impact might be softer, too. In that case, targeting stable, high-quality companies with a track record of sustainable payouts makes sense.

But if you’re still in the ‘wealth accumulation’ phase, then chasing high dividend yields might slow you down. You’d likely be better off focusing on total returns: a combination of capital gains and income, rather than just what lands in your account each quarter.

So, where does this leave us?

Dividends are not magic. They’re not inherently good or bad. They’re just one way a company can share its profits. And just like the government is using dividends as a tool to improve its cash flow without raising taxes, investors can use dividends as a way to build short-term income, but remember that it does affect the long-term performance of your portfolio.

Sure, it’s tempting to buy a stock just because it offers a 6% or 7% yield. But, after every dividend announcement, ask whether the company can still grow, whether its balance sheet stays strong after the dividend is paid out, and whether your after-tax yield beats what you could earn by letting those profits compound inside the firm. Only when the answer to all three is ‘Yes’ does a dividend become a gift rather than a costly comfort.

Until then…

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Disclaimer: This article is for informational purposes only and should not be construed as investment advice. Investing in the stock market involves risk, and readers should consider their individual financial goals, risk tolerance, and consult a qualified financial advisor before making any investment decisions. The examples and references in this article are illustrative and do not constitute recommendations to buy or sell any securities.

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