Invest more in equity mutual funds to get more tax benefits

You would need to hold a debt mutual fund for more than three years to qualify for beneficial long-term capital gains treatment


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With regards to debt mutual funds, how can one save on taxes, and at the same time have a strong portfolio?

—Akshata Patra

All gains from debt mutual funds are subject to some level of taxation. This is in contrast to equity funds where gains after a holding period of a year are considered long-term gains and are exempt from taxes.

In the case of debt funds, the definition of long-term has been changed in the recent years from one year to three years. You would need to hold a debt mutual fund for more than three years to qualify for beneficial long-term capital gains treatment. Gains from investments held less than three years would be considered short-term gains and will be added to your income and taxed at your tax slab rate.

For long-term gains, you can choose to take advantage of indexation when calculating tax that means you will have to pay taxes on only gains you make from your investment that are in excess of the nominal rate of inflation. Equity funds get a highly favourable tax treatment, and you should have as much equity exposure in your portfolio as your risk appetite and investment time frame would allow. Also, you can invest in balanced funds as they have exposure to debt in their portfolio, but still qualify as equity funds as far as tax treatment goes (as they invest at least 65% in domestic stocks). Another thing is the fund option you choose while selecting debt funds. If you are in the 10% or 20% tax slab, always go for growth option for debt funds over the dividend one. This is because dividends are compulsorily subject to a 28% dividend distribution tax that would be higher than the tax you pay if it came to you in the form of growth in net asset value.

Finally, when you need to withdraw money from your investments to create a regular income stream, it would be prudent to go for systematic withdrawal plan. This is because that would follow the first-in-first-out method, therefore maximising your tax-saving potential.

I am 26 years old and earn Rs.50,000 a month. Please suggest different mutual fund schemes for investing through monthly systematic investment plan (SIP) of Rs.1,500 for 15-20 years.

—Atul Raikwar

Starting investments at a young age is a great thing, but you are planning on investing Rs.1,500. This sum of money is not sufficient to invest in more than one or two schemes, and given your salary, you should strive to save more every month. The thumb rule is to be able to save 20% of your salary every month. Even if you can’t get there, you should strive to get to at least 10% or Rs.5,000 in your case.

As a beginner, it would be good for you to start with a balanced fund such as HDFC Balanced that invests both in equity and debt. If you intend to increase your SIP amount, consider adding more aggressive funds, such as, Birla Sun Life Frontline Equity fund and BNP Paribas Midcap fund.

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