It is important to understand the nature of investment and the risks associated before thinking of taxation

The other day I received a query from someone. This person was advised to invest his money in fixed income funds since the money was needed in around two years’ time. He wanted a second opinion.

His question was: “Should I not look at equity funds since the returns on fixed income funds would be taxable, whereas capital gains on equity funds after a holding period of one year would be exempt from long term capital gains tax. Similarly, I can also opt for dividend option, too as dividends are also tax-free.”

Here is my article published in Mid-day Gujarati today


The English translation is as under:

Should you invest in equity funds since these are more tax-efficient?

The other day I received a query from someone. This person was advised to invest his money in fixed income funds since the money was needed in around two years’ time. He wanted a second opinion.

His question was: “Should I not look at equity funds since the returns on fixed income funds would be taxable, whereas capital gains on equity funds after a holding period of one year would be exempt from long term capital gains tax. Similarly, I can also opt for dividend option, too as dividends are also tax-free.”

He quoted an oft repeated line “It is not what you make, it is how much you take home after taxes that counts”.

He was also convinced that equity funds have potential to offer higher returns that fixed income funds.

This combination of potential higher returns coupled with lower (zero, in this case) tax makes equity funds appear far superior to fixed income funds.

Both the arguments in favour of equity funds are right – potential for higher returns and that the tax-efficiency is far superior. What is missing here is the risk involved. The risk is very high that even a well managed and well diversified portfolio of equity shares may lose value periodically. Though such drops in value may be temporary, they do exist and sometime for long periods of time.

It is this risk that should be considered first before worrying about paying taxes. Many investors make this mistake of looking at the taxation first. This results in highly tax-efficient but sometimes highly risky portfolios. It is not just in case of equity, we have seen this fascination towards saving tax in many other areas of personal finance. However, we shall restrict our discussion in this article only to the question we started with.

While equity funds have the potential for providing higher returns than fixed income funds, such a statement is more likely to be true if the holding periods are long. The price fluctuations in the short term would render the fund vulnerable. One is likely to experience a highly volatile NAV in case of an equity fund as compared to a fixed income fund.

These fluctuations may result into a situation that the value of investments could be lower when one needs money. Our investor had a need for taking money out of investments in around two years.

To answer the investor above, what he was advised was the correct investment option. With a two year investment horizon, it is prudent to invest in fixed income funds. To put it another way, it would be too risky to consider investing in equity funds if the investment horizon is two years.

Consider the nature of investment first – the risk involved before you look at the taxes.if the value of the portfolio is down at the time of redemption, there would be no taxed, anyway. It is often better to pay taxes on investment income than to see a situation when the investment loses money.

Use equity funds for your long term needs and fixed income funds if the need is short term in nature.

-        Amit Trivedi

The author runs Karmayog Knowledge Academy. Recently, Amit has authored a book titled “Riding the Roller Coaster – Lessons from Financial Market Cycles We Repeatedly Forget”. The views expressed are his personal opinions.

Answers to questions about mutual funds and investing

Here is the transcript of the chat on www.moneycontrol.com

Equity investments simplified

Santa Claus is coming along ...

A couple of years ago, I wrote an article around Christmas time. We tend to be stuck so much to the calendar that many of our discussions are about dates, months or periodic events like Diwali or Christmas. We tend to assume that the market also celebrates all our festivals. In this context, I came across a term "Santa Claus rally" while surfing through the net.

Here is my take on it. Click here to read further ...

Are all rules of thumb trustworthy in personal finance?

Rules of thumb are approximations and one should not over rely on these rules. It is better to take a bit more cumbersome but accurate route. Read on ...

The importance of a mutual fund account statement

Click on the link below to read my article in Mid-day Mumbai edition today:

http://epaper.gujaratimidday.com//epaperpdf/gmd/20072015/20072015-md-gm-11.pdf


The English translation is as under:

“Can you please provide me the information of your investments?” Asked the financial adviser to the client. The client answered: “I invested so much in XYZ mutual fund, this much in ABC mutual fund, …, etc.” The adviser was not satisfied with the answer, as he wanted to know the current value of the investments.

The client was unable to understand the question, as they were talking on phone. The adviser suggested that they meet. He also requested the client to carry the account statements for the meeting.

How the adviser helped the client to know the value of investments?

When an investor invests in a mutual fund scheme, one gets an account statement. This statement looks quite like a bank statement in that it contains the record of various transactions the investor has done in the account as well as the current balance and any dividends one has received. The statement also contains some basic details of the investor and the mode of holding.

As far as the investor’s question in the discussion above is concerned, the account statement serves an important purpose. An investor can see the unit balance in the respective mutual fund scheme folio. Multiplying this unit balance with the current NAV of the scheme gives the current value of investments.

While how much money you invested is important to know, after a while, it is important to know how much money has been accumulated in this account.

An account statement, as mentioned earlier, also shows the cumulative value of the dividends paid by the scheme in this investment folio. This gives a good idea to the investor about how much Rupee returns one has made.

One should be careful to understand that the total returns one has got through the investments cannot be simply added as what one received few years ago cannot be equated with what one got now. The concept of “time value of money” is important for anyone interested in the study of investments and loans.

How often can one get an account statement?

Actually, any number of times. A mutual fund account statement is just a document that records the transactions and unit balance, it can be obtained from the office of the mutual fund company or the registrars any number of times one wants. There are no charges levied for this. Mutual fund companies also offer online services to the investors, which help an investor check the current value of investments anytime and from anywhere. Today, there are mobile phone applications also that help one check the current value of investments.

Investing in mutual funds is quite simple. Checking the current value of investments is even simpler.

Amit Trivedi

The author runs Karmayog Knowledge Academy. Recently, Amit has authored a book titled “Riding the Roller Coaster – Lessons from Financial Market Cycles We Repeatedly Forget”. The views expressed are his personal opinions.

"All mutual funds are equity funds" - it's just a misconception

Not all mutual funds invest in equity - and still many continue to believe so ...

Read my article on the above topic http://epaper.gujaratimidday.com//epaperpdf/gmd/30032015/30032015-md-gm-12.pdf


--------------------------------------------------------------------------------------------------------------------------

Here is the English translation of the article:

“The mutual funds must be doing well these days! Is this a good time to start investing in mutual funds?” – someone asked the other day.

Such questions are quite common these days. And it has been the same in the past, too. Whenever the equity markets have gone up, many consider that mutual funds must be doing well. On the other hand, during a bear phase in equity market, many think that even the mutual funds are also going through a bear phase. This strong link between mutual funds and equity markets is a big misconception that lots of investors are living with.

In order to address the misconception, we need to understand what a mutual fund really is.

All of us need to manage the surplus money we have saved out of our income. The money must be managed such that we have enough available to provide for our various needs in future. How do we manage our money? There are two major alternatives – do it yourself or get help. Whose help do you get? One professional whose help you may take is a fund manager or the asset management company. An asset management company manages a mutual fund portfolio. this firm has to launch a scheme that would be managed in a particular manner. In order to explain how the scheme would be managed, the asset management company must disclose where the money would be invested (also known as asset allocation) and the style adopted by the managers of the scheme.

Such a disclosure helps investors decide if the scheme can help them in their investment plan. You see, investors start with their own investment plan and then choose mutual fund schemes that are in line with their own objectives.

Seen in this manner, investing through a mutual fund is equivalent of outsourcing the investment management work.

With that, let us understand the options available among the mutual funds, as there are different schemes investing in different investment categories – equity, fixed income, and gold. With that, thee could be different types of schemes – debt funds, equity funds, gold funds, liquid funds as well as hybrid funds, which are a combination of one or more of the above. Different funds serve different purposes. Equity funds offer potential for growth; debt funds offer stability to the investment portfolio; liquid funds offer high liquidity with safety of capital; and gold funds help investors take exposure to gold.

All mutual funds are not equity funds. In fact, mutual fund is a vehicle that helps you invest in a variety of investment options. Understand the scheme and check if it matches with your requirements.

Thus, answering the question asked in the beginning – anytime is a good time to invest, if you have surplus money. Instead of time, one needs to focus on one’s own situation and requirements and there would be an option available from among the mutual fund schemes.

Happy investing!

Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.

Stupid or victim - which feels better? - My article on www.moneycontrol.com

Investors get carried away by short term performance of asset classes. After the expected returns do not materialise, there is a tendency to blame the external factors such as advisor's influence than lack of home work by the investor himself.

Read more at: Stupid or victim - which feels better

Index funds - a good idea for a first time equity investor

My article on Index Funds in Gujarati Mid-day, Mumbai edition

http://epaper.gujaratimidday.com//epaperpdf/gmd/29122014/29122014-md-gm-12.pdf


The English translation is as under:

Top of Form

Index funds

“What do you suggest for a first time investor in equity markets?”

One has seen many a first-timers start with penny stocks – the stocks of small companies quoting below Rs. 10. Some of these investors lose money, have a bad experience and then pledge never to return to equity markets. Some others make money in the short run and learn incorrect lessons – for example, some become overconfident about their skills. Some others lose money in the beginning, but learn the right lessons – by paying too high a fee to the ultimate teacher – the stock market. All these experiences are avoidable.

Someone entering the equity markets for the first time would be well advised to take the mutual fund route, learn about investing and then, if at all, try hands at stocks. However, even within the equity mutual funds, there are too many choices and it becomes difficult for one to make a good selection.

That leads to another set of questions: “Which fund manager is better?” “What if a good fund manager turns out poor performance?” well, to make things simpler, one may consider investing in an index fund. In this way, there is no question of selection or fund manager performance. How does an index fund work?

An index fund is designed to track the movement of a market index. This makes it easier for an investor to track the portfolio performance. For example, a fund tracking the popular index Sensex would move in line with the movement of Sensex. If Sensex moves up by 10%, the fund’s NAV should also move up by around 10%. We mentioned the word “around” in the previous line, since there would always be some difference between the performance of the fund and the index. This difference is called “tracking error”. A good index fund would have low tracking error.

Though there are many factors contributing to the tracking error, one important factor is the expenses charged by the mutual fund company.

SEBI has prscribed limits beyond which a fund cpompany cannto charge the scheme. For index funds, the ceiling of expenses is lower than than the actively managed schemes. The reason for this is simple: in an index fund, there is no role of a fund manager in selection of securities to buy/sell or the timing of such decisions.

An index fund could track a popular index like Sensex or Nifty, or it could track a wider index like S&P 500. We also have index funds tracking an industry – Bank Index or a PSU Bank Index. There are funds in the Indian market that help investors invest in international markets, e.g. NASDAQ, Hang Seng, etc. In developed markets, there are index funds tracking even the bond indices.

Today, with the available variety in this segment, an investor can conveniently and cheaply get exposure to variouis different segments of the market or different markets.

While selecting an index fund, one should consider the following points:

1.     The index being tracked,

2.     Tracking error of the fund – this indicates how the scheme has been managed in the past – lower the better

3.     Expense ratio – this would contribute to the future tracking error – lower the better

There is no need to look at any other factor while selecting an index fund.

In the end, let us consider the question regarding out- or under-performance. Will an index fund generate superior returns over actively-managed funds? The answer is very clear. The index is nothing but an average and an average will always generate average performance.

There will always be some funds that will do better than the index. The problem is that it is almost impossible to identify future winners in advance.

Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.

Bottom of Form