The Finance Act 2023 has created a third category for taxation in mutual funds. We are all aware that debt funds no longer qualify for LTCG benefits. They will be taxed at marginal rate of taxation irrespective of the holding period.
In this context, the Finance Act has defined debt funds as funds having domestic equity exposure of less than 35%. Hence, it includes other categories of funds like gold funds and international FOFs.
However, the definition has opened up a new category of mutual funds from the perspective of taxation. This category is funds having exposure to equity between 35% and 65%. These funds will continue to get indexation benefits if the holding period exceeds 36 months. The category of multi asset fund (at least 10% exposure in three asset classes) may fall under this taxation ambit, depending on the positioning by the AMC. If the equity component of the fund is more than 65%, it will be taxed as equity. If the equity component is between 35% to 65%, it will be eligible for indexation. Balanced hybrid fund (50% exposure to both equity and debt) fall under this category, but currently there is no balance hybrid fund in the industry.
There are couple of multi asset funds in the market answering this description i.e. equity in the range of 35% to 65% and eligible for indexation. Certain fund houses are launching multi asset funds to benefit from this tax arbitrage.
Conclusion
The extent of indexation benefit for LTCG depends on inflation. However, history shows that post-indexation, the effective LTCG tax rate is less than 10% in most of the years, which is the taxation rate for equity funds.
SEBI Circular no. SEBI/HO/IMD/DF3/CIR/P/2019/166 dated December 24, 2019 has prescribed the uniform process to be followed across Asset Management Companies (AMCs) in respect of investments made in the name of a minor through a guardian. Based on recommendation of Mutual Fund Advisory Committee, it has been decided as under:
1. In partial modification to the above SEBI circular, it has been decided as under:
i. Para 1(a) shall read as under:
“Payment for investment by any mode shall be accepted from the bank account of the minor, parent or legal guardian of the minor, or from a joint account of the minor with parent or legal guardian. For existing folios, the AMCs shall insist upon a Change of Pay-out Bank mandate before redemption is processed”
ii. Irrespective of the source of payment for subscription, all redemption proceeds shall be credited only in the verified bank account of the minor, i.e. the account the minor may hold with the parent/ legal guardian after completing all KYC formalities.
iii. All other provisions mentioned in the aforesaid circular shall remain unchanged.
2. All AMCs are advised to make the necessary changes to facilitate the above changes in mutual fund transactions w.e.f. June 15, 2023.
3. This circular is issued in exercise of the powers conferred under Section 11 (1) of the Securities and Exchange Board of India Act, 1992, read with Regulation 77 of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996 to protect the interests of investors in securities and to promote the development of, and to regulate the securities market.
A big outcome from the Finance Bill amendment on March 24 is that post-April 1, mutual fund schemes will be subject to three different types of taxation. On schemes that invest 35-65 percent in equities, you will now pay Short-Term Capital Gains (STCG) tax in line with your income tax rates; long-term capital gains (LTCG) will attract 20 percent tax with indexation.
To be sure, the Finance Bill has removed the capital gains tax and indexation benefits for debt funds that invest less than 35 percent in equity. In the third category of taxation, nothing changes for funds that invest at least 65 percent in equities.
For the Rs 40 trillion mutual fund industry struggling to come to terms with the latest tax shocker, this new category of taxation has changed little. The fact that hybrid funds were left untouched by the Finance Bill amendment actually opens new opportunities.
The question is: should you really switch to hybrid funds, if you’re affected by higher taxation on you debt fund investments?
MF industry officials and experts say that the 35-65 percent equity category, which largely makes up hybrid mutual fund schemes, would be under the spotlight.
Hybrid funds comprise six categories: Conservative Hybrid, Balanced Hybrid/Aggressive Hybrid, Balanced Advantage, Multi Asset Allocation, Arbitrage, and Equity Savings.
Hybrid schemes with total Assets Under Management (AUM) of Rs 4.87 trillion are the second-lowest open-ended mutual fund category after Solution Oriented Schemes. Compared to this, Growth/Equity Oriented Schemes commanded AUM of Rs 15.01 trillion as of February-end.
Dynamic Asset Allocation/Balanced Advantage funds, which are expected to benefit from the tax changes, are the most popular categories among the hybrid schemes with AUM of Rs 1.91 trillion.
A better alternative?
Experts say that with a slight upgrade in their risk profile, hybrid funds can offer a better alternative when it comes to generating returns, over and above fixed deposit rates.
In this category, equity allocation can move anywhere between 20 percent and 80 percent or even 0-100 percent depending on market conditions. Currently, 30 such funds are available in the market, but most are keeping their equity exposure in the range of 65-100 percent and debt in range of 0-35 percent.
Equity Savings is a neglected category among hybrid schemes with the lowest AUM of Rs 16,445 crore. But that could change soon.
“For retail investors, hybrid funds would make more sense. BAFs and Equity Savings may come in handy for retail investors as they can take debt allocation in a tax-efficient way,” said Niranjan Awasthi, Head of Products Marketing and Digital Business at Edelweiss Asset Management Company.
Equity Savings and Arbitrage Funds
In Equity Savings, minimum investment in equity is 65 percent and minimum investment in debt is 10 percent while arbitrage is also allowed.
In mutual funds, arbitrage is the simultaneous purchase and sale of a stock to take advantage of the price differential in the spot and futures markets. This helps in increasing the equity exposure in the scheme while avoiding a rise in the risk profile.
Experts say that Equity Savings have largely remained neglected as retail investors generally look at equity allocation in hybrid funds. Case in point, Conservative Hybrid, where equity allocation can stay between 10 percent and 25 percent, has a total AUM of just Rs 22,716 crore.
Kirtan Shah, founder of Credence Wealth Advisors LLP, believes that a lot of money will start flowing into Equity Savings.
“Asset management companies will start pushing Equity Savings as a category for fixed income kind of investments. These funds, in four or five years of history, have kept equity in the 20-30 percent range. If you look at all the other hybrids, the equity range is much higher,” he said.
Apart from Equity Savings, the expert also sees money starting to flow into Arbitrage Funds.
“A pure debt replacement will move to Arbitrage and Equity Savings. However, the problem is that in both these categories, if a lot of money starts flowing in, then automatically the spreads will reduce on the arbitrage. That is one big problem that can arise in the future. If we are anticipating that Arbitrage and Equity Savings will see a lot of flows, then the return expectations have to be slightly tempered,” Shah added.
Can hybrid replace debt?
Over the past few days, fund houses have gone on an overdrive suggesting that investors put as much money into debt funds as they can until March 31 to take advantage of lower taxation.
Many experts say that while some people may feel the urgency to shift out of debt mutual funds to save some taxes, they will realise eventually that debt funds can still outperform traditional FDs. There may just not be other credible options available in their risk profile.
Dhirendra Kumar, CEO, Value Research, said, “In terms of taxation, nothing changes for Liquid funds, Ultra-Short Term and Money Market Funds. Debt funds can give investors great convenience, and also a little better return. Plus, for a fixed income investor, equity is risky. In March 2020, the equity went down by around 30 percent in a few days, and that time people were running for cover and they hate equity for that.”
Experts are also of the opinion that investors shifting from debt to equity will risk having a complete change in their risk profile.
Swarup Mohanty, director and chief executive officer (CEO), Mirae Asset Investment Managers (India), does not like selling a hybrid fund to a debt fund investor. “That’s the worst thing that can happen.”
Edelweiss’ Awasthi added: “Specifically, for longer-tenured bond funds and Target-Maturity Funds, there will be times, even like now (high interest rate regimes), where funds which are closely comparable to a fixed deposit, would still do well.” When interest rates fall, bond prices rise; this benefits your debt funds.
What should mutual funds do?
According to Mohanty, the mutual fund industry used to talk about fixed deposits versus income funds in the early 2000s.
“Maybe we have to start from there now, now that the taxation is similar,” he said.
Deepak Chhabria, CEO of Axiom Financial Services, says that if the debt industry has to survive, it has to bring in alpha compared to other fixed-income products.
“In early 2000s, the return on say a long bond fund used to be around 1 percent higher than the corresponding deposit rate. With indexation and tax benefit, it used to be a decent 1.5-2 percent alpha. That alpha over a period disappeared because of the competitive pressure. The pitch has to change, there has to be an additional return and safety will have to come in too,” said Chhabria.
Another aspect debt mutual funds may look to work on is simplification of language so that they can make themselves understood to lay investors.
“The language that we speak; long debt, duration, CAGR (Compounded Annual Growth Rate), compared to a simple FD 8 percent interest is very complicated. We have had the benefit of taxation until now, but debt sales will continue as usual,” said Mohanty.
Just like any other income, gains made on your investments are taxable and mutual funds are no exception. However, taxation policy can change depending on the type of mutual fund you hold. Similarly, tax consequences change depending on when you decide to sell your mutual fund.
But worry not because this article will help you understand the different tax implications of mutual fund investments.
Tax arises only when you book a profit
Unlike fixed deposits (FD), where the accrued interest is taxed every year, mutual fund gains are taxable only when they are realised, i.e., at the time of redemption. For example, if you invest in an FD for three years and earn Rs 5,000 interest every year, this amount is added to the taxable income of that year even if you do not realise the interest.
However, in case of mutual funds, if the value of your investment increases by Rs 15,000 by the end of the first year and you remain invested, you don’t have to pay any tax. Only when you redeem your mutual investment do you need to pay tax.
How tax liability is determined on mutual fund gains?
How much tax you need to pay on your mutual fund gains depends on three factors:
The type of fund you have invested in: From a taxation point of view, mutual funds can either be equity-oriented or non-equity-oriented.
Equity-oriented funds are those that invest at least 65 per cent of your money in equities. The others are termed as non-equity-oriented mutual funds.
The amount of time you have held on to your mutual fund: Your holding period can either be short-term or long-term. The duration to define this is different for equity-oriented mutual funds and non-equity mutual funds
Your tax slab: This is only applicable if you invest in a non-equity mutual fund. Tax slabs also apply to Income Distribution cum Capital Withdrawal (IDCW) plans of mutual funds too. But more on this later.
Tax implications on equity-oriented funds
If your holding period is more than a year, the gains are termed as long-term capital gains. In this case, gains up to Rs 1 lakh in a financial year are tax-free, but anything above that is subject to a 10 per cent tax.
If your holding period is less than a year, the gains are termed as short-term capital gains and are taxed at 15 per cent.
Tax implications on non-equity funds
If you invest in a non-equity mutual fund, and your holding period is less than three years, the gains are termed as short-term capital gains and are added to your income. They is taxed as per your income tax slab rate.
If your holding period is longer than three years, then the gains are termed as long-term capital gains and are taxable at 20 per cent after indexation.
The first-in-first-out principle
Another important thing you should know is that the redemption of mutual fund units is based on the first-in-first-out (FIFO) method. That is, the units that you bought first are assumed to be redeemed first.
For example, let’s say you bought 100 units of a non-equity fund in September 2017, and 150 units of the same fund again in September 2021. In total, you would have 250 units. Now suppose you wish to sell 120 units in August 2022, here is how your tax liability would look like. For the first 100 units, gains made will be considered as long-term as they were acquired in September 2017, i.e., more than three years ago. And the gains on the remaining 20 units will be treated as short-term as they were purchased less than a year back. So, keep this in mind while evaluating your tax liability.
Tax on income distributed by mutual funds
If you opt for the Income Distribution cum Capital Withdrawal plan (IDCW) of any mutual fund scheme, the fund house might give you some portion of the gains/capital from time to time. Such distributions are added to your total income and taxed as per your income tax slab rates.
Mutual funds are a convenient investment option that helps you build wealth. They allow you to invest in a wide variety of stocks and other securities at a much lower cost than investing in them directly.
For individual investors who don’t have the time to study and research investments, mutual funds are the best option because there are professional fund managers who decide where and how to invest. Additionally, it is possible to start investing with as little as a few hundred rupees, even in the top-performing mutual funds. Unlike many other investments, mutual fund investments can be exited without any delay. So, let’s understand how mutual funds work by understanding them in greater detail.
Types of mutual funds
There are three broad types of mutual funds:
• Equity funds: These predominantly invest in stocks. Equity helps you earn high returns but it also fluctuates in the short-term, which is why people consider it risky. However, this volatility falls drastically if you plan to invest for a longer time horizon. So, if you plan to invest for five years or more, equity funds are the most suitable for creating wealth over the long-term.
• Debt funds: These funds invest in securities such as corporate bonds, government securities and other instruments that provide fixed income. Given their low-risk, low-return profile, they are better suited to meet short-term goals because preserving your money here is more important than the returns you make.
• Hybrid funds: This type of mutual fund is a combination of equity and debt funds. Their charm lies in being less volatile than pure equity schemes. These funds typically do well enough when markets go up and fall less sharply when markets drop due to the cushion provided by the debt component.
While there are hundreds of mutual fund schemes in India, we believe most investors should keep the fund selection process simple and look at only a handful of categories. For beginners, the choice is rather simple as we will see in the next section.
Where to invest?
If you are a beginner, the focus should be to make a decent return by taking low risk. Only after you get the taste of equity investing can you get into a more nuanced investment strategy. Here, we present the two best mutual funds for you:
Aggressive hybrid funds: This type of mutual fund invests about 65 per cent in equities and 35 per cent in debt. Their advantage is that the equity portion is high enough to give you decent returns and the debt component minimises the equity volatility. Softening the risk is necessary for new investors like you so that you are psychologically strong to stay the course and do not end up exiting the fund in panic when the markets fall.
Tax-saving funds: If you are looking to save tax, tax-saving funds – also known as equity-linked savings scheme (ELSS) – are a good option. They are pure equity funds where the majority of the funds’ assets are invested in large-cap stocks. However, these funds have a lock-in period of three years. But this is an advantage for new investors who can’t handle the market volatility and also helps one have a long-term view, which is the holy grail of equity investing.
Before you invest
You might have now got a fair idea of how mutual funds work and are ready to make your first purchase. But before you do, you need to have a bank account and be KYC compliant, which is a one-time procedure. Know how to get your KYC done . Nowadays, you can easily complete your KYC online. Once your verification is done, you are set to invest in mutual funds.
Points to remember
Every mutual fund scheme comes in two variants – a direct plan and a regular plan. There’s no difference between the two, except for the commission – also known as expense ratio – charged from the investors.
Regular plans have a higher expense ratio as it needs to pay a commission to the agent/distributor. These distributors help investors with mutual fund investing and take care of the investment process on the investors’ behalf. If you want to reduce these extra fees, you can go for a direct plan. But remember that you will have to do everything yourself.
Further, both regular and direct plans have two more options – Growth and IDCW. In the growth plan, the fund house reinvests all the gains you make, such as dividends received from stocks and realised gains from the underlying assets, back into the fund. Thus, the NAV of growth plans keeps growing with these reinvestments. In IDCW (Income Distribution cum Capital Withdrawal) plans, fund houses pay out some portion of the gains to investors. The quantum of payout and timing is as per the choice of the AMC.
So which one is better? We suggest you keep it simple and always opt for the growth option. It is more tax-efficient and gives you more control over when and how much you redeem.
Monitoring and managing your investments
Once you’ve made your investment, you must keep a track of how well they are performing. It’s not necessary to look at them every day because equity investments go up and down and constantly looking at them adds anxiety. So, review your investments once or twice a year.
Gone are the days when redeeming your mutual funds was a lengthy and hectic process. For this, one had to go to a branch, fill extensive forms and only then one was able to liquidate one’s investment. The process has become much simpler over the years. Funds can now be easily redeemed online with a click of a button.
However, before redeeming your mutual fund schemes, make sure to consider a few things so that your investment is not impacted. Even though there is no hard-and-fast rule that pinpoints the right or the best time to redeem a mutual fund scheme, there are some situations under which investors could consider exiting or redeeming their mutual fund investments.
For instance, if your fund is consistently underperforming, or if there are changes in objectives of the scheme that are no longer in line with your goals, you could consider redeeming your funds. Additionally, if you find out that there are many similar types of funds in your portfolio, selling some of them could give the investor’s portfolio a more diversified look.
Here are some of the instances when you should consider exiting your fund;
Change in asset allocation
Various asset classes such as equity funds, debt funds, balanced funds, etc. are included in mutual fund schemes. The asset allocation of a mutual fund scheme depends on the type of scheme it falls under. For instance, while most equity funds usually invest fully in equities, some schemes also split their allocation between equity and the rest in other sectors such as debt or allocation between domestic and international equity. While a fund manager can change allocations, but only within the limits specified, not beyond them.
Here is how the spread looks like for,
i) equity funds – invest 80 per cent–100 per cent in equity and/or 0–20 per cent in money market securities;
ii) balanced funds – 65 to 80 per cent in equity and/or 15 to 35 per cent in debt securities, and 0 to 20 per cent in money market securities.
Usually, experts say asset allocations change due to differential returns from various asset classes. Market movements also impact asset allocation significantly. Under such circumstances, if the fund no longer suits your goals, or is not in line with your risk appetite, you could plan on redeeming the fund.
Approaching goals
Among the various advantages of mutual funds, their ease of buying and selling, professional management, inbuilt diversification mechanisms, are some of the top factors that make them ideal for investors to meet their future goals and financial requirements. Therefore, if you are nearing the financial goal that you were saving for, and you need money, you could redeem your funds.
Industry experts usually suggest, when the goal deadline is 2 to 3 years away, an investor should move his/her moving from equity mutual funds (with long-term objectives) to debt funds, as they are liquid and good for short-term goals.
A Systematic Transfer Plan (STP) might be the best way to go about this. Similar to the process of SIP, it allows investors to periodically transfer/redeem certain units from one scheme and invest in another scheme of the same mutual fund house.
Changed or Postponed goals
We all know that chances of returns go up exponentially with the duration one stay invested in mutual funds. Simply put, the longer you stay invested in it, the more are the chances of higher returns. However, different type of goals needs different duration to stay invested.
For instance, for short term goals such as buying a car or going on a short vacation, one might need to invest in a mutual fund for roughly two or three years. While long-term goals such as buying a house the investment tenure could be 7–8 years or even more.
Therefore, if you start investing with a short-term goal in mind, and a few months down the line, you change your mind and think of directing the investment for a long term goal, you can do so but you are required to also make changes in the asset allocation of the scheme. It is so because, while a short term investment will be more inclined towards safer options like debt funds, long term goals require investments in equity funds. Hence, a change of goals could also be the reason to redeem your mutual funds.
Under-performance
It is always suggested by financial planners and advisers never to time the market, and as mutual funds are market-linked instruments, it is quite normal to see falling returns, especially over the short term.
However, you should only worry about your fund’s performance, after checking how other funds in the category have performed, or are performing. If your fund has been underperforming as compared to the peer group for more than two years or so, it should be a signal for you to exit that fund and move on.
We don’t invest thoughtfully in equity because we try to follow the mantra “buy low, sell high” and fail to do it. It is seen that when markets hit rock bottom, most investors focus on exiting their investments to preserve their capital rather than trying to take advantage of lower prices and deploying additional capital. Or they do not think long term and put off their investment.
The common reasons investors give when they wish to avoid or postpone their investment are…
“It’s too late!”
Or “It’s not a good time.”
Or “Why should I invest now?”
Or “When should I invest in Mutual funds?”
Or “What is the best time to invest in mutual funds?”
If you too are giving these reasons when it comes to investing, then you are making a big mistake. Remember, you should not delay investing; start your investment journey right away! The best time to start your investment journey, if you haven’t already started, is ‘Today’!
Here are a few tips to help you begin your investment journey.
1. Do Not Delay, It Can Cost You
When we stall or avoid investing, we are simply delaying or completely evading successful wealth creation. Delay in investing reduces the power of compounding as the investment term decreases.
To understand better, let us see the amount three friends – Ajay, Vijay and Ram – would get at the end of their investment tenure. If Ajay starts investing INR 2,000 per month at the age of 25, for his retirement at age 60, and two of his friends, Vijay and Ram, begin investing 5 and 15 years later, respectively, then the future values of each will be different.
It is seen in Table 1 that the future value reduces with the reduction in the investment term (subtract the age of the person from the retirement age).
Table 1: Effect of delayed investment
Even though they have all earned the same rate of returns per annum on their investment, Ajay who started investing early will have the biggest corpus by far at the time of retirement. Therefore, starting the investment journey early is a boon, if you want to build a huge corpus for your financial goals.
In fact, let us assume that even though Vijay delays his investment by five years, he invests an additional sum of INR 1.20 lakh per annum to catch up with Ajay, and Ram invests INR 3.60 lakh per annum to catch up with both. Even then, the corpus will be INR 1.11 cr for Vijay and INR 99.05 lakh for Ram, which is less compared to Ajay’s future value. The difference is nothing but the cost of delay.
2. Choose the Right Asset to Deal with Volatility and Risk
Choosing the right asset is important as it will help in growing wealth for you. Equity as an asset class can help you grow your wealth manifold but along with higher returns comes its volatile nature, which investors tend to confuse with risk.
Volatility reduces over a period of time but risk may not. Risk is about choosing the right product. For example, if you chose a company with bad management, it could be a risk; irrespective of how the market moves, the price of the share may never appreciate.
The stock of Kingfisher Airlines is a perfect example (graph 1). The stock in 2006 was at INR 76, and later in 2007 it reached its peak of nearly INR 300+ only to fall drastically and never recover. In the end, an investor would have lost all his money because the stock was delisted. This is a classic example of a risky proposition which resulted in a permanent loss; but it was not volatility.
Graph 1: Price movement of Kingfisher Airlines
Now, if instead you choose a company with good management, the price may be stagnant and may not move for a really long period of time, but eventually it will deliver results. Choosing a management is risk and the price movement is about volatility. Volatility is a market related phenomenon and risk is more intrinsic.
For example, the price of Reliance Industries remained within the range of INR 400 to INR 500 from 2010 till January 2017. Later, the stock rallied and has kept its momentum (as seen in graph 2). The stock price moved from INR 544 in February 2017 to INR 2,370.25 in December 2021.
Graph 2: Price movement of Reliance Industries
When you choose equity mutual funds you are investing in a basket of multiple stocks of various companies. This diversification prevents you from larger losses when the market gets tepid. So while you still have to deal with volatility, the risk factor is reduced. This is one of the primary reasons that mutual funds are an ‘all season’ investment plan.
Equity markets by nature will be volatile. It is a given. In the short term the volatility will be more and as the time horizon increases, volatility reduces.
The best way to understand volatility is to look at rolling returns. In the table 2 given below the maximum and minimum rolling returns over 20-year periods have been taken.
What this means is that if you had invested on any day during this period and held the investment for one year, your minimum return was -51.70% and maximum return was 97.32%. As the time period increases the difference between the two becomes less. In the third year, the minimum returns are negative still, but the gap between the negative and positive maximum returns reduces.
Further, in the 5th year, the minimum returns have turned positive along with maximum returns and the difference between the two has decreased further. Lastly, in the 10th year, the difference between the minimum and maximum returns narrows and both are positive. So, if an investment was held for 10 years, an investor never made a loss and the minimum return made was 6.38% and the maximum was 22.08%. In reality, the investor’s actual return would be somewhere in between.
Table 2: Volatility range
So, to grow wealth by investing in equity mutual funds, you should think long term as the volatility tapers and only the minimal market risk remains.
3. Invest Regularly and Diligently
While investing in equity mutual funds, do it via systematic investment plans (SIPs) as you are reducing the risk factor further by investing a fixed amount at regular intervals, irrespective of prevalent market conditions. This is because when markets are down, you get more units and when markets are up you buy fewer units.
For example, if you are investing INR 10,000 monthly in a SIP and assuming that the Sensex drops by 5% every month for the next 6 months and then it rises 5% every month for the remaining six months, at the end of the year, the amount you receive is INR 1,45,971 on an investment of INR 1.20 lakh even though you saw a rise of 30% and then a drop of 30% in the markets.
If you observe, you started with an NAV of INR 10 and at the end it was again back to around INR 10 after a year (refer table 3 below).
The Sensex is just a reference point to show market movements.
So, SIP investing in an equity mutual fund, irrespective of market movements, is an extremely helpful tool in the hands of the investor.
4. Be Patient and Disciplined
The road to wealth generation requires patience and discipline, just as Rome was not built in a day. Over a short term period, the market is very volatile and the returns generated are in a broader range. But over the longer time period, market volatility subsides and the returns are within a narrow range.
For example, look at the performance chart given below of a large cap fund vis a vis the S&P BSE Sensex over 15 years. You can see that despite the sharp falls in the years 2008-2009 (Lehmann crisis), 2015-2016 (post-election) and March 2020 (COVID crisis) in the graph 3, the fund has done well and outperformed the S&P BSE Sensex.
If an investor had invested INR 10,000 in HDFC Top 100 Fund in Jan 2006, when the Sensex was up in December 2007, the value reached INR 19,451. Later when there was a market fall between 2008 and 2009, the value crashed back to 10,602 (March 2009). However, if the investor continued to stay invested, the value was at INR 55,202 in Jan 2018.
Now if the investor had been patient, for a span of 12 years, the value increased nearly 5x, but in March 2020, the value dropped to INR 39,495 consequent to the Covid scare. However, if the investor continued to hold on, the value as on date would be INR 77,516.
This shows that when you invest in equity, being patient helps you grow wealth.
Graph 3: Long-term growth despite short term volatility
Values taken to the base of INR 10,000
When you invest in equity mutual funds you don’t have to worry about the stock selection process. Instead, you should focus on your goal and continue investing systematically, without giving in to market turbulence related panic.
There are roughly 250 trading days a year, making it 2500 days for a decade. A large portion of a stock’s return in a decade happens in 50 to 60 trading days. This means that what happens in 2% of the days, decides your decadal returns.
Even market guru Warren Buffet, advocates that, “Successful Investing takes time, discipline and patience. No matter how great the talent or effort, some things take time: You can’t produce a baby in one month by getting nine women pregnant.”
Therefore, when you invest in equity mutual funds, be patient, show perseverance, diligence and let your funds grow, without timing the market. Time in the market is of essence.
Bottom Line
We earn monthly and we spend monthly; so why shouldn’t we cultivate the habit of investing on a monthly basis? Treat an investment journey as a marathon not a sprint. So think long term, and equity mutual funds are an ideal product to create long term wealth if you follow two mantras for investment: the best time to invest is now and the best way to invest is regularly, in other words every month.
Spend today, or save for tomorrow? The former gives us a rush of instant pleasure, while the latter helps us build a solid future for ourselves and our families. However, what’s the point of putting in long hours at the office if you cannot enjoy the fruits of your labour – at least partially? The key lies in maintaining a balanced approach between saving and spending so that one act does not cannibalise the other. Also, it’s essential to invest in mutual funds through SIP’s to let your ‘savings’ compound and grow over the long term. Here are seven things all smart spenders tend to do. You should, too!
1. They save first
While reckless spenders indulge themselves to their content the day their paychecks hit their accounts, smart spenders save for their financial goals first. They’ve usually got a well-documented financial plan in place,
and with it, they have a fair degree of awareness about just how much they need to put away each month to make these dreams a reality. Having saved first, smart spenders enjoy the luxury of ‘guilt-free spending’.
2. They have a written budget in place
The boring old budget is the bedrock of the smart spender’s financial plan. By earmarking sums of money each month for things such as home purchases, dining out, electricity, fuel, and the like, they inadvertently follow the tried and tested ‘coffee can’ system of bucketing monthly spending.
If they exceed their budget in one category in a given month (say, a great play hits but the tickets cost a bomb), they cover the deficit by scrimping on another one ( clothes bought for one month never killed anyone!).
3. They ‘sleep’ on large purchases
Smart Spenders avoid the infamous “buyers regret” syndrome by delaying the impulse to make big-ticket purchases before properly thinking them through. Tempting as that 100-inch flat-screen TV seems to them as they stroll past it in the mall, smart spenders will rarely succumb to the impulse buy.
Instead, they’ll head home and contemplate the purchase decision and its ramifications with the mind. If it still seems good tomorrow, they’ll head right back to the mall and buy it!
4. Occasionally, they observe ‘fiscal fasts’
Smart spenders are known to go on self-inflicted ‘fiscal fasts’. These purchase hiatuses could last from a few weeks to a few and can be very cathartic indeed. By restricting themselves to only spending on ‘needs’ and not ‘wants’ for a few weeks in a year, smart spenders effectively deleverage themselves – scaling back on money-draining, costly credit and stabilising their financial situations in the process.
In doing so, they also build their willpower to resist impulse purchases that could potentially set off a vicious cycle of unhappiness-inducing credit.
5. They don’t bother with ‘keeping up with the Jones’s
Smart spenders understand that buying things merely to impress others is utterly futile, and akin to a never-ending race with a constantly shifting goalpost. They buy things with the singular intent of making themselves happy.
They never overextend their finances and spend their future incomes by taking on expensive personal loans or strapping on EMIs on their credit cards. In other words, they spend what they have, and for themselves alone.
6. They know that saving isn’t investing
Smart spenders understand that saving money alone won’t make them rich unless they invest it fruitfully. Instead of procrastinating their investments, they deploy their savings into mutual fund investment plans through SIP’s, to secure their financial futures. Without curtailing their financial freedom, they invest in mutual fund SIP’s, which allow them to amounts as small as Rs. 500 per month.
7. They believe in ‘tax-saving’ wealth creation
Smart spenders invest in tax-saving mutual funds and enjoy ‘tax-saving wealth creation’. They start their SIP’s into tax-saving mutual funds early on in the financial year and enjoy deductions under Section 80(C) in the process.
Smart spenders usually choose ELSS mutual funds over traditional tax-saving instruments, which give them the dual benefits of tax saving and wealth creation.
When it comes to Retirement Planning, Mutual Funds Sahi Hai! No investment instrument’s as flexible and customizable as Mutual Funds can be adapted to optimize your Retirement Planning goal at its various stages. Here’s a simple guide to using Mutual Funds to achieve your Retirement Planning Goal effectively and efficiently.
The Early Stages: SIPs in Equity Funds
The best time to start planning for your retirement is when you take up your first job and receive your first paycheck.
After all, the money you put away at this stage of your life will have not years, but decades to compound and grow! During the early stages of your Retirement Planning, make sure you run SIP’s (Systematic Investment Plans) in aggressive funds such as small & mid-cap funds, without paying much heed to market volatility or even your risk tolerance.
The Mid Stages: Aggressive Step Ups
When you’ve spent a decade or so in your career, you’ll likely start witnessing some serious bump-ups in your income levels. This is the time that you should be stepping up your monthly SIP amounts aggressively.
Unfortunately, left to your own devices, you’ll probably keep putting off this well-intentioned step up for a ‘better time’. A solution to this procrastination is to issue a standing instruction to the Mutual Fund to increase or “Step Up” your monthly SIP installments every year automatically.
Pre-retirement: STP’s into Debt Funds
When you’re 3-5 years away from your retirement, you’ll likely have accumulated a sizeable corpus if you’ve been disciplined in running your Mutual Fund SIP. However, your priority right now will be to safeguard your hard-won capital and ensure no erosion in its value.
Therefore, this is the time that you should say “Debt Mutual Funds Sahi Hai” and start STP’s (Systematic Transfer Plans) from your Equity Mutual Fund investments to lower risk fixed income funds! By staggering your investment out of equity funds, you’ll end up averaging your exit cost, and ensuring that you get a fair value for your units and don’t risk cashing out at the bottom of a cycle.
Post Retirement: SWP’s from Debt Funds
Once you’ve retired, the lion’s share of your corpus will be parked into debt-oriented mutual funds, and your overarching objective will be to generate a reliable, constant income stream from it to meet your day-to-day expenditures.
For doing this, you should start an SWP (Systematic Withdrawal Plan) from your debt funds to the tune of your monthly requirement. SWP’s are a tax-efficient means of generating post-retirement income and are highly flexible. With proper planning, they should help you sail through your retirement years comfortably!
One common inference emerges singularly in all Financial Planning surveys in India – planning for our kids’ education is always going to be a top priority for Indian parents! Although this aspiration hasn’t changed over the years, the way we save for this critical goal has undergone dramatic shifts.
Gone are the days when investors looked no further than “Child Education Insurance Plans” to fund their kids’ higher studies. With AMFI’s impactful “Mutual Funds Sahi hai” campaign, has come the awareness that a low cost, potentially high return, and transparent tool exists for Child Education Planning, in the form of Mutual Funds.
Here are the three stages of accumulating wealth for your Child’s Higher studies using Mutual Funds.
Stage 1: Accumulation
The accumulation stage must ideally commence as early as possible – smart investors start accumulating money via Mutual Fund SIP as soon as their children are born! During the accumulation phase, it would be wise to not pay too much attention to your risk profile and instead focus on making affordable monthly investments into mid-cap-oriented mutual funds that have high volatility.
If you can achieve a 14% return over 18 years (not uncommon for many top-performing mid-cap oriented mutual funds), even a small saving of Rs. 5,000 per month can yield Rs. 50 Lakhs by the time your child turns 18.
Stage 2: Aggressive Step Ups
When it comes to saving for your Child’s Education using Mutual Funds, it’s of critical importance to re-evaluate your financial situation now and then and step up your monthly outgo accordingly. Since education costs tend to inflate at supernormal rates, a college degree that costs Rs. 50 Lakhs today will most likely cost between Rs. 2.25 Cr – Rs. 2.50 Cr, 18 years hence.
But fret not – starting with Rs. 5000 per month; but stepping this monthly contribution up by just Rs. 3000 per month every year for 18 years, can help you accumulate nearly Rs. 2 Cr for your kid’s higher studies. Such is the magic of the power of compounding when coupled with regular and disciplined annual step-ups.
Stage 3: De-risking & Corpus Deployment
The final stage in planning for your child’s education using Mutual Funds would be to systematically de-risk your portfolio as the goal date approaches. A common mistake that savers make is to continue to have a 100% allocation to equities to the goal date.
This can prove to be catastrophic if market cycles turn unfavorable in the year that you need to redeem money. Imagine, for a moment, that a 2008-like situation was to arise in the year that you need to redeem funds to pay your child’s tuition fees or college seat booking amount.
You may need to take a loan at that stage to circumvent the horrifying prospect of booking a 50% loss on your hard-won savings! Instead, make sure you begin STP’s (Systematic Transfer Plans) from your high-risk equity funds to lower-risk debt funds a good 3 years before your goal date. This will help you safeguard your capital as well as your profits, making them easily redeemable when you need to write that hefty check!
