July 2014

Latest Cost of Inflation Index March 2014 & Double indexation benefits.

Latest Cost of Inflation Index March 2014 , Double indexation benefits, Short term debt, 30% tax bracket, Investing strategies, year end tax planning

Cost of Inflation Index upto FY 2013-14. (The year mentioned is financial year(FY) 

The cost of inflation index is useful for income-tax assesses in the computation of tax on long-term capital gains (for indexation purposes). In the previous two years, the cost inflation index rose 10 per cent and 12.5 per cent, respectively.

A cost inflation index helps reduce the inflationary gains, thereby reducing the long-term capital gains tax payout for the taxpayer. Currently, the income-tax law allows long-term capital gains to be computed after adjusting for inflation (Debt Mutual Funds, FMP’s, Real Estate Gains etc.) .

The cost of acquisition as well as the cost of improvement is adjusted for inflation between the date of purchase and date of sale (through the cost inflation index) before the long-term capital gain is ascertained.

Assume, if the investor invested Rs 1,00,000 in the growth option on March 30, 2012 and redeemed the investment on April 2, 2013 for Rs 1,10,000 

The investment happened in financial year 2011-12, for which the government has declared cost inflation index of 785.

The investor redeemed the investment in financial year in 2013-14, for which the cost inflation index is 939.

The capital gains is Rs. 110,000 minus Rs. 100,000 i.e. Rs. 10,000.

The holding period is 367 days, which is more than 1 year. Therefore, it is a long term capital gain.

The maximum tax the investor has to bear is 10% (plus surcharge plus education cess) on the capital gain of Rs. 10,000. Thus, the maximum tax payable would be Rs. 1,000 (plus surcharge plus education cess).

Investor can benefit from indexation. The indexed cost of acquisition is Rs. 100,000 X 939 ÷ 785 i.e. Rs. 119,618 . This is higher than the selling price of Rs. 110,000. Thus, the investor ends up with a long term capital loss of Rs. 9,618. So no tax payable and also this can be set off against long term capital gains, as discussed in the next section.

Another point to note is that although the investor held the investment for slightly more than a year, the investor gets the benefit of indexation for two years viz. 2011-12 and 2012-13. Hence the name “double indexation” for such structures.

Mutual funds tend to come out with fixed maturity plans (FMP’s) towards the end of every financial year to help them benefit from such double indexation. Even short term debt is a good investment towards the financial year end, as they too offer the same benefits. 

Largely investors are unaware about this benefit. This benefit can and should be taken by investors who are in 30% tax bracket as they get the maximum benefit. So, invest in wither FMP’s or Short term Debt (Holding period > 1 yr) towards the end of a financial year, and sell towards the beginning of a financial year and take advantage of   double indexation tax benefit for virtually tax free capital gains. Money saved is indeed Money earned.

Be Money Savvy and invest smart. Happy Investing. 

July 2013

Why RBI has hiked the Base Rate on Jul 15 & Implications

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Reserve Bank Of India (RBI) announced several measures day before yesterday late evening to tighten liquidity in the system and arrest depreciation of rupee.  Why RBI wants to tighten liquidity and why the urgency.

RBI had tightened liquidity to support rupee during Asian crisis:

Historically, During the Asian crises of 1997-98, the RBI raised its benchmark interest rate by three percentage points in one go to 8%, in order to attract capital from foreign investors. The RBI had raised the bank rate and cash reserve ratio of banks too. This had sucked out liquidity, and interest rates had skyrocketed. This checked the run on the rupee.

The reason for this move and its impact:

Liquidity had eased considerably in June and that had brought the overnight rates (also CP, CD) rates below the Repo rate. With these measures, RBI will be able to raise the effective short term interest rate considerably without hiking the policy rate. (more…)

June 2013

Increase in Dividend Distribution Tax from June 01 2013 in Debt Mutual Funds – Impact

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In the FY14 Budget the Finance Minister has proposed to increase the Dividend Distribution Tax (DDT) on Debt Mutual Funds (other than liquid and money market funds on which the DDT was already 25%) from 12.5% to 25% (plus surcharge and cess) for individuals and HUFs. The hike is proposed to provide uniform taxation for all types of funds other than equity oriented mutual funds in the Mutual Fund Industry.
This amendment will take effect from 1st June, 2013.

Classification of Funds: As far as tax implications on Indian mutual funds are concerned, they are classified as three parts as ‘Equity oriented Funds’, ‘Liquid and money market Funds’ and ‘Debt Funds other than Liquid Funds’.

In ‘Equity Oriented Funds’, the categories coming under are Equity Diversified, Equity Sector, Hybrid – Equity Oriented (more than 65% equity) and Arbitrage Funds.

Liquid Funds and Liquid ETF are coming under ‘Liquid Funds’ while Ultra Short Term Funds, Floating Rate Funds, Short Term Income, Dynamic Income, Income Funds, Gilt Funds, Fund of Funds, Hybrid – Debt Oriented (less than 65% equity), MIP, FMPs are coming under ‘Debt Funds other than Liquid Funds’.,

Summary of Changes proposed :

Classification of Debt funds , Short term taxation , dividend distribution tax DDT, Effective yield


Tax on distributed income:Given the tax provision on the distributed income, fund houses pay taxes on the dividend distributed to the investors. Fund houses deduct DDT from the Dividend. So the dividends are tax free in the hands of investors.
Existing tax structure on DDT:As per the existing structure, there is no tax levied on the dividend distributed by Equity oriented mutual fund schemes for any investors. But, Liquid and money market Funds are liable to pay the DDT of 25% (plus surcharge and cess) for retail investors while the funds other than Liquid and money market funds are liable to pay DDT of 12.5% (plus surcharge and cess).

For institutions and corporates, DDT on Equity funds is nil while 30% (plus surcharge and cess) in case of the dividends from the investments in Liquid Funds and debt funds other than Liquid funds.

Proposed Structure: From June 01, 2013 onwards, retail investors who invest in all debt funds (other than equity funds) are liable to pay DDT of 25% (plus surcharge and cess) on the dividend income. The DDT for corporate investors has been kept unchanged at 30% (plus surcharge and cess).
Increase in Surcharge: Further, the surcharge on Dividend Distribution Tax for all mutual fund schemes has gone up from 5% to 10%.
Impact: This move will make dividend options in Debt Mutual Funds unattractive for retail investors. Because the net post tax return in the hands of the investors from dividend plans would be lower as the DDT charged on the debt funds has been increased from 12.5% to 25% (plus surcharge and cess). Meanwhile, the Growth options in the Debt Mutual Funds will become attractive for retail investors who redeem the investments after a year, taking advantage of long term capital gains.

Capital Gain: Since the DDT is applicable for Dividend plans, Capital Gains tax is applicable to Growth plans. The gains from the debt mutual scheme (growth option) are taxed depending on the period the investments in the mutual funds are kept. If the debt mutual fund units are redeemed after a year, then the gains thereon are liable to Long Term Capital Gain tax while the proceeds from the investments which redeemed before one year are taxed as Short Term Capital Gain. For long term capital gains in debt funds, the investor has to pay the tax @ lesser of 10% without indexation or 20% with indexation; (plus education cess). Short Term Capital Gain is taxed as per the normal slab of the investors. (more…)

May 2013

Understanding the various terminologies used in Debt Markets!!!

Understand the various terms in Fixed INcome, Debt Market, What is Repo Rate, Reverse Repo, Yield to Maturity, Modified Duration

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The debt market in India consists of mainly two categories—the government securities (g-secs) markets comprising central government and state government securities, and the corporate bond market. The g-secs are the most dominant category of debt markets and form a major part of the market in terms of outstanding issues, market capitalization, and trading value.

In order to finance its fiscal deficit, the government floats fixed income instruments and borrows money by issuing g-secs that are sovereign securities issued by the Reserve Bank of India (RBI) on behalf of the Government of India. The corporate bond market (also known as the non-gsec market) consists of financial institutions (FI) bonds, public sector units (PSU) bonds, and corporate bonds/debentures.

Listed below are the various terminologies used in the fixed income market:

Coupon: A coupon payment on a bond is a periodic interest payment that the bondholder receives during the time between when the bond is issued and when it matures. Coupons are normally described in terms of the coupon rate, which is calculated by adding the total amount of coupons paid per year and dividing by the bond’s face value.

Maturity: Maturity refers to the term of the bond i.e. the date on which the issuer has to repay the principal amount to the bondholder.

Yield to maturity: The Yield to maturity (YTM) is the internal rate of return or the discount rate at which the sum of all future cash flows from the bond (coupons and principal) is equal to the price of the bond. (more…)

January 2013

Understand the Risks in Debt Mutual Funds

risks in debt mutual funds, credit risk, interest rate risk, reinvestment risk, yield curve, YTM, yield to maturity

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Debt funds carry indexation benefits and hence are more tax efficient than FD’s. Many financial planners recommend debt funds as a replacement for FD’s. However the debt funds do carry certain risks.

And it makes sense to be aware of those risks.

Investments in debt funds are subject to various risks like credit risk, interest rate risks, liquidity risks, market risks, reinvestment risks etc. Let us look at what these risks mean and how understanding these risks can make you a better investor.

1. Credit Risk : This refers to the risk that the issuer of a fixed income security may default (which means that, he will be unable to make timely principal and interest rate payments on the security)

2. Interest rate risks : This risk results from the change in demand and supply of money and other macroeconomic factors and creates price changes in the value of debt instruments. Hence, the NAV of the scheme may change due to the fluctuations. Prices of long term securities generally fluctuate more in response to interest rate changes than do short term securities. Thus, this risk may expose the schemes to capital erosion.

3. Liquidity Risk : This refers to the ease with which the security can be sold at or near to it’s valuation yield-to-maturity (YTM).

4. Market Risk : Market perception of interest rate sensitivity, general market liquidity, credit worthiness etc. may cause price volatility and hence lead to capital erosion.

5. Reinvestment Risk : This risk refers to the interest rate levels at which cash flows are received for the securities in the scheme is reinvested. The risk is that the rate at which the interim cash flows can be reinvested may be lower that that originally assumed.

So, how do fund managers try to mitigate these risk factors :

a. Interest rate risk : By keeping the maturities of the schemes in line with interest rate expectations. (Note the key here is expectations, so if the expectations go wrong, the strategy can mis fire).

b. Credit Risk or Default Risk : By investing in high investment grade fixed income securities rated by SEBI registered credit rating agencies. Eg: investing in AA/A rated securities carry a higher credit risk compared to AAA rated securities. Note, historically, though , the default rates for investment grade securities (BBB & above) has been less.

c. Reinvestment Risk : This is limited to the extent of coupons received on the debt instruments, which will typically be a very small portion of the portfolio

d. Market risks : The schemes may take positions in interest rate derivatives to hedge this risk.

Understand the risks, become aware and deal with these risks to make informed decisions towards building wealth.

You can read more about debt mutual funds here.

October 2012

Cost of Inflation Index AY 2012-13 ~ Long term Capital Gains ~ Double Indexation

Double Indexation, FMP, Cost of Inflation Index AY 2012-13 ,To compute Long term Capital Gains Indexation, AY 2012-13, Tax Planning, Fixed Maturity Plans, Debt Funds Taxation, Real Estate Capital Gains
COST INFLATION INDEX TABLE – FINANCIAL YEAR 1981-82 ONWARDS:
Assessment Year (AY)
Financial Year (FY)
Cost Inflation Index (CII)
2014-15
2013-14
2013-14
2012-13
852
2012-13
2011-12
785
2011-12
2010-11
711
2010-11
2009-10
632
2009-10
2008-09
582
2008-09
2007-08
551
2007-08
2006-07
519
2006-07
2005-06
497
2005-06
2004-05
480
2004-05
2003-04
463
2003-04
2002-03
447
2002-03
2001-02
426
2001-02
2000-01
406
2000-01
1999-2000
389
1999-2000
1998-99
351
1998-99
1997-98
331
1997-98
1996-97
305
1996-97
1995-96
281
1995-96
1994-95
259
1994-95
1993-94
244
1993-94
1992-93
223
1992-93
1991-92
199
1991-92
1990-91
182
1990-91
1989-90
172
1989-90
1988-89
161
1988-89
1987-88
150
1987-88
1986-87
140
1986-87
1985-86
133
1985-86
1984-85
125
1984-85
1983-84
116
1983-84
1982-83
109
1982-83
1981-82
100

The cost of inflation index is useful for income-tax assesses in the computation of tax on long-term capital gains (for indexation purposes). In the previous two years, the cost inflation index rose 10 per cent and 12.5 per cent, respectively.

A cost inflation index helps reduce the inflationary gains, thereby reducing the long-term capital gains tax payout for the taxpayer. Currently, the income-tax law allows long-term capital gains to be computed after adjusting for inflation (Debt Mutual Funds, FMP’s, Real Estate Gains etc.) .

The cost of acquisition as well as the cost of improvement is adjusted for inflation between the date of purchase and date of sale (through the cost inflation index) before the long-term capital gain is ascertained. (~ The Hindu)

Assume, if the investor invested Rs 1,00,000 in the growth option on March 30, 2009 and redeemed the investment on April 2, 2010 for Rs 1,10,000 

The investment happened in financial year 2008-09, for which the government has declared cost inflation index of 582.

The investor redeemed the investment in financial year in 2010-11, for which the cost inflation index is 711.

The capital gains is Rs. 110,000 minus Rs. 100,000 i.e. Rs. 10,000.

The holding period is 367 days, which is more than 1 year. Therefore, it is a long term capital gain.

The maximum tax the investor has to bear is 10% (plus surcharge plus education cess) on the capital gain of Rs. 10,000. Thus, the maximum tax payable would be Rs. 1,000 (plus surcharge plus education cess).

Investor can benefit from indexation. The indexed cost of acquisition is Rs. 100,000 X 711 ÷ 582 i.e. Rs. 122,165. This is higher than the selling price of Rs. 110,000. Thus, the investor ends up with a long term capital loss of Rs. 12, 165. This can be set off against long term capital gains, as discussed in the next section.

Another point to note is that although the investor held the investment for slightly more than a year, the investor gets the benefit of indexation for two years viz. 2009-10 and 2010-11. Hence the name “double indexation” for such structures.

Mutual funds tend to come out with fixed maturity plans towards the end of every financial year to help them benefit from such double indexation. 

Largely investors are unaware about this benefit. This benefit can and should be taken by investing towards the end of a financial year, if the investor has surplus funds, because the capital gains virtually becomes tax free due to the double indexation benefit.

What are debt funds ~ Know more about this important asset class

What are debt funds , Yield spread, Interest rate risk, Credit risk, Asset allocation, Mutual funds, How to invest in debt funds, Liquid Funds, FMP, Short term debt, Long term debt, Corporate Bonds

 

Many investors are ignorant of the advantages of investing debt funds investment avenue as an asset class. They prefer to keep funds in FD’s and other traditional debt instruments like PPF/KVP’s/NSC/Post Office etc ~ primarily due to lack of knowledge.

This post will throw some light on the different kinds of debt funds and how they work.

Investment in a debt security,  entails a return in the form of interest (at a pre-specified frequency for a pre- specified period), and refund of a pre-specified amount at the end of the pre-specified period.

The pre-specified period is also called tenor. At the end of the tenor, the securities are said to mature. The process of repaying the amounts due on maturity is called redemption.

Debt securities that are to mature within a year are called money market securities.

The return that an investor earns or is likely to earn on a debt security is called its yield. The yield would be a combination of interest paid by the issuer and capital gain (if the proceeds on redemption are higher than the amount invested) or capital loss (if the proceeds on redemption are lower than the amount invested)

Debt securities may be issued by Central Government, State Governments, Banks, Financial Institutions, Public Sector Undertakings (PSU), Private Companies, Municipalities etc.

  • Securities issued by the Government are called Government Securities or G-Sec or Gilt.
  • Treasury Bills are short term debt instruments issued by the Reserve Bank of India on behalf of the Government of India.
  • Certificates of Deposit are issued by Banks (for 91 days to 1 year) or Financial Institutions (for 1 to 3 years)
  • Commercial Papers are short term securities (upto 1 year) issued by companies.
  • Bonds / Debentures are generally issued for tenors beyond a year. Governments and public sector companies tend to issue bonds, while private sector companies issue debentures.

    Since the government is unlikely to default on its obligations, Gilts are viewed as safe. The yield on Gilt is generally the lowest in the market. Since non-Government issuers can default, they tend to offer higher yields. The difference between the yield on Gilt and the yield on a non-Government Debt security is called its yield spread.

The possibility of a non-government issuer defaulting on a debt security i.e. its credit risk, is measured by Credit Rating companies like CRISIL, ICRA, CARE and Fitch. They assign different symbols to indicate the credit risk in a debt security. For instance ‘AAA’ is CRISIL’s indicator of highest safety in a debenture. Higher the credit risk, higher is likely to be the yield on the debt security.

The interest rate payable on a debt security may be specified as a fixed rate, say 6%. Alternatively, it may be a floating rate i.e. a rate linked to some other rate that may be prevailing in the market, say the rate that is applicable to Gilt. Interest rates on floating rate securities (also called floaters) are specified as a “Base + Spread”. For example, 5-year G-Sec + 2%. This means that the interest rate that is payable on the debt security would be 2% above whatever is the rate prevailing in the market for Government Securities of 5-year maturity.

The returns in a debt portfolio are largely driven by interest rates and yield spreads.

Interest Rates

Suppose an investor has invested in a debt security that yields a return of 8%. Subsequently, yields in the market for similar securities rise to 9%. It stands to reason that the security, which was bought at 8% yield, is no longer such an attractive investment.

It will therefore lose value. Conversely, if the yields in the market go down, the debt security will gain value. Thus, there is an inverse relationship between yields and value of such debt securities which offer a fixed rate of interest.

A security of longer maturity would fluctuate a lot more, as compared to short tenor securities. Debt analysts work with a related concept called modified duration to assess how much a debt security is likely to fluctuate in response to changes in interest rates.

In a floater, when yields in the market go up, the issuer pays higher interest; lower interest is paid, when yields in the market go down. Since the interest rate itself keeps adjusting in line with the market, these floating rate debt securities tend to hold their value, despite changes in yield in the debt market.

If the portfolio manager expects interest rates to rise, then the portfolio is switched towards a higher proportion of floating rate instruments; or fixed rate instruments of shorter tenor. On the other hand, if the expectation is that interest rates would fall, then the manager increases the exposure to longer term fixed rate debt securities.

The calls that a fund manager takes on likely interest rate scenario are therefore a key determinant of the returns in a debt fund – unlike equity, where the calls on sectors and stocks are important.

Yield Spreads

Suppose an investor has invested in the debt security of a company. Subsequently, its credit rating improves. The market will now be prepared to accept a lower yield spread. Correspondingly, the value of the debt security will increase in the market.

A debt portfolio manager explores opportunities to earn gains by anticipating changes in credit quality, and changes in yield spreads between different market benchmarks in the market place. (~ source:NISM)

Remember that Debt funds are more tax efficient that FD’s. You can read about taxation on Capital Gains on debt Mutual Funds here.

Be aware of this asset class and use it to judiciously optimize your asset allocation towards reaching your financial goals. 

This article – Guide to debt funds & article – Debt funds can prove beneficial from Economic times further articulates the tax advantages & other benefits of investing in debt funds. 

Measures of Risk ~ Equity & Debt

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Measures of Risk, Performance, Mutual Funds , Stocks, Standard Deviation, Variance, Beta, Modified duration, Credit Risk, Interest Rate Risk, Weighted Average Maturity  ,Yield Spread,

Investors generally focus on the returns of any asset. They largely ignore the risk factors and most importantly are ignorant of the measures of risk. 

And so, the real Risk comes from not knowing what they are doing ~ Warren Buffett

This post talks about the measures of risks in equities & debt. The awareness of the measures of risk is extremely helpful in designing a comprehensive financial plan, investing, asset allocation etc.

Fluctuation in returns is used as a measure of risk.

Therefore, to measure risk, generally the periodic returns (daily / weekly / fortnightly / monthly) are first worked out, and then their fluctuation is measured.

The fluctuation in returns can be assessed in relation to itself, or in relation to some other index. Accordingly, the following risk measures are commonly used.

Variance

Suppose there were two stocks, with monthly returns as follows: Stock 1: 5%, 4%, 5%, 6%. Average=5%  & Stock 2: 5%, -10%, +20%, 5% Average=5%

Although both stocks have the same average returns, the periodic (monthly) returns fluctuate a lot more for Stock 2. Variance measures the fluctuation in periodic returns of a asset, as compared to its own average return. This can be easily calculated in MS Excel using the following function:

=var(range of cells where the periodic returns are calculated)

Variance as a measure of risk is relevant for both debt and equity.

Standard Deviation

Like Variance, Standard Deviation too measures the fluctuation in periodic returns of a scheme in relation to its own average return. Mathematically, standard deviation is equal to the square root of variance.

This can be easily calculated in MS Excel using the following function: =stdev(range of cells where the periodic returns are calculated)

Standard deviation as a measure of risk is relevant for both debt and equity schemes.

Beta

Beta is based on the Capital Assets Pricing Model, which states that there are two kinds of risk in investing in equities – systematic risk and non-systematic risk.

Systematic risk is integral to investing in the market; it cannot be avoided. For example, risks arising out of inflation, interest rates, political risks etc.

Non-systematic risk is unique to a company; the non-systematic risk in an equity portfolio can be minimized by diversification across companies. For example, risk arising out of change in management, product obsolescence etc.

Since non-systematic risk can be diversified away, investors need to be compensated only for systematic risk. This is measured by its Beta.

Beta measures the fluctuation in periodic returns in a scheme, as compared to fluctuation in periodic returns of a diversified stock index over the same period.

The diversified stock index, by definition, has a Beta of 1. Companies or schemes, whose beta is more than 1, are seen as more risky than the market. Beta less than 1 is indicative of a company or scheme that is less risky than the market.

Beta as a measure of risk is relevant only for equity schemes.

Modified Duration

This measures the sensitivity of value of a debt security to changes in interest rates. Higher the modified duration, higher the interest sensitive risk in a debt portfolio.

The returns in a debt portfolio are largely driven by interest rates and yield spreads.

Interest Rates

Suppose an investor has invested in a debt security that yields a return of 8%. Subsequently, yields in the market for similar securities rise to 9%. It stands to reason that the security, which was bought at 8% yield, is no longer such an attractive investment.

It will therefore lose value. Conversely, if the yields in the market go down, the debt security will gain value. Thus, there is an inverse relationship between yields and value of such debt securities which offer a fixed rate of interest.

A security of longer maturity would fluctuate a lot more, as compared to short tenor securities. Debt analysts work with a related concept called modified duration to assess how much a debt security is likely to fluctuate in response to changes in interest rates.

In a floater, when yields in the market go up, the issuer pays higher interest; lower interest is paid, when yields in the market go down. Since the interest rate itself keeps adjusting in line with the market, these floating rate debt securities tend to hold their value, despite changes in yield in the debt market.

If the portfolio manager expects interest rates to rise, then the portfolio is switched towards a higher proportion of floating rate instruments; or fixed rate instruments of shorter tenor. On the other hand, if the expectation is that interest rates would fall, then the manager increases the exposure to longer term fixed rate debt securities.

The calls that a fund manager takes on likely interest rate scenario are therefore a key determinant of the returns in a debt fund – unlike equity, where the calls on sectors and stocks are important.

Yield Spreads

Suppose an investor has invested in the debt security of a company. Subsequently, its credit rating improves. The market will now be prepared to accept a lower yield spread. Correspondingly, the value of the debt security will increase in the market.

A debt portfolio manager explores opportunities to earn gains by anticipating changes in credit quality, and changes in yield spreads between different market benchmarks in the market place.

Weighted Average Maturity

While modified duration captures interest sensitivity of a security better, it can be reasoned that longer the maturity of a debt security, higher would be its interest rate sensitivity. Extending the logic, weighted average maturity of debt securities in a scheme’s portfolio is indicative of the interest rate sensitivity of a scheme.

Being simpler to comprehend, weighted average maturity is widely used, especially in discussions with lay investors. However, a professional debt fund manager would rely on modified duration as a better measure of interest rate sensitivity. 

More on Mutual Funds

How are Mutual Fund Gains Taxed?

Capital Gains Tax, Equity Mutual Funds, Debt Mutual Funds, Indexation Benefits, FMP's, Balanced Mutual Funds.

Capital Gain is the difference between sale price and acquisition cost of the investment. Since mutual funds are exempt from tax, the schemes do not pay a tax on the capital gains they earn.

Investors in mutual fund schemes however need to pay a tax on their capital gains as follows:

Equity-oriented schemes

– Nil – on Long Term Capital Gains (i.e. if investment was held for more than a year) arising out of transactions, where STT has been paid

– 15% plus surcharge plus education cess – on Short Term Capital Gains (i.e. if investment was held for 1 year or less) arising out of transactions, where STT has been paid

– Where STT is not paid, the taxation is similar to debt-oriented schemes

Debt-oriented schemes

– Short Term Capital Gains (i.e. if investment was held for 1 year or less) are added to the income of the investor. Thus, they get taxed as per the tax slabs applicable. An investor whose income is above that prescribed for 20% taxation would end up bearing tax at 30%. Investors in lower tax slabs would bear tax at lower rates. Thus, what is applicable is the marginal rate of tax of the investor.

– In the case of Long Term Capital Gain (i.e. if investment was held for more than 1 year), investor pays tax at the lower of the following:

— 10% plus surcharge plus education cess, without indexation

— 20% plus surcharge plus education cess, with indexation

Indexation means that the cost of acquisition is adjusted upwards to reflect the impact of inflation. The government comes out with an index number for every financial year to facilitate this calculation.

For example, if the investor bought units of a debt-oriented mutual fund scheme at Rs 10 and sold them at Rs 15, after a period of over a year. Assume the government’s inflation index number was 400 for the year in which the units were bought; and 440 for the year in which the units were sold. The investor would need to pay tax on the lower of the following:

— 10%, without indexation viz. 10% X (Rs 15 minus Rs 10) i.e. Rs 0.50 per unit

— 20%, with indexation.

Indexed cost of acquisition is Rs 10 X 440 ÷ 400 i.e. Rs11. The capital gains post indexation is Rs 15 minus Rs 11 i.e. Rs 4 per unit. 20% tax on this would mean a tax of Rs 0.80 per unit.The investor would pay the lower of the two taxes i.e. Rs0.50 per unit.

Here’s how different funds are taxed and who should invest in them:

Debt schemes held for short term: If you fall under 10% tax bracket, growth option would be better—as there is no DDT (13.519%). Dividend option is better if an individual falls under higher income brackets (20% or 30% & above) as the DDT is lower. Debt schemes if held for short term ( less than one year), then capital gains tax will added to income and taxed according to the slab.

Debt funds held for long term: If you want to invest in debt schemes for more than a year, growth option is a better choice. In case of debt schemes, long term capital gains are taxed at 10% without indexation and 20% with indexation.

This article – Guide to debt funds & article – Debt funds can prove beneficial from Economic times further articulates the tax advantages & other benefits of investing in debt funds. 

Source : NISM

 More on Mutual Funds

August 2012

Mutual Funds and the associated charges

Mutual Funds, AMC Charges, Entry Load, Exit Load, India's Top Mutual Funds, Debt funds, FMC, Equity Funds, Hybrid Funds, Balanced FundsThere is a lot of talk of revamping the Mutual Fund Business in India which has taken a serious downfall over the past few years, ever since the entry load was banned ~ which forced the distributors to literally run away from the business. IN the coming few months, there might be some changes like bringing in some entry load,providing additional tax benefits, incentives for promoting mutual fund business in Tier II cities, providing a common AMFI platform to provide a seamless tracking system etc.

Here is a list of the charges which one should be aware when buying a mutual fund :

Mutual funds are an excellent route to create wealth for yourself. However, they do not come cheap. They have some charges. Some visible, some invisible. You need to be aware of the charges, that is all. Let us look at some of the charges:

1. Entry load: this is charged to pay the distributor for the sales effort that he/she puts in to make the sale. Normally this is nil for debt funds and about 2% for equity funds. (At present there are no entry load charges in Mutual Funds)

2. Brokerage paid for buying and selling of shares – this is a hidden charge because it gets adjusted in the NAV – the net asset value, and you only see the net sale/ purchase. However, as is evident, a fund with a higher churn – a lot of buy and sell transactions – pays a higher cost. It hurts and hurts bad.

3. Chargeable costs: the fund house is allowed to charge some expenses – like audit fees, trusteeship fees, custodian charges, mandatory communication expenses, marketing expenses, etc. The limit here is 2.5% p.a. This is charged on the market value of the assets and hurts – especially when the fund does well

4. Trail commission: In order to encourage distributors from keeping the assets in one amc, amcs pay a trail fee – and this is part of the allowable expense – and thus comes out of the Nav. It is not clear what happens to the money that comes in as “direct” and on which there is no “entry load”. Think about this. God bless you.

5. Charges: The total costs of running an equity fund in India may be high or low by international rates. Do you know how much you are paying – well you are paying about 2.15% per annum. This includes all expenses – allowed by SEBI. If you think debt funds charge less, well you are mistaken. They charge about 1.25%. You will find Templeton India Income Builder charging about 2.15%. You like it? Well, lump it.

Source : Subramoney.com

September 2010

Top Performing Balanced Mutual Funds

Top Performing Balanced Mutual Funds, India, .

I was looking up for good Balanced Funds to help a friend and thought of putting this up for my own reference.

Balanced mutual funds invest in both equity and debt. Here is the list of some of the good – balanced mutual funds in India, based on the 5 year returns.

Balanced mutual funds are treated as equity funds for tax purposes when the fund allocates at least 65% into equities on an annual average fund amount.

There are various kinds of  Mutual funds for Investors to choose from. Balanced Mutual Funds is one category where there is a mix of Equities and Debt. These mutual funds take care of the asset allocation between equities and debt for the Investor.

Fund 5 Year Return (%) Inception Date Expense Ratio
HDFC Prudence 17.02 Jan-94 1.82%
HDFC Children’s Gift-Inv 12.08 Feb-01 2.10%
HDFC Balanced 13.7 Aug-00 2.15%
Reliance Regular Savings Balanced 16.06 May-05 2.22%
Birla Sun Life 95 15.54 Feb-95 2.33%
Canara Robeco Balance 11.57 Jan-93 2.39%
DSPBR Balanced 14.13 May-99 2.08%
Tata Balanced 12.75 Oct-95 2.50%
FT India Balanced 11.85 Dec-99 2.35%
Principal Conservative Growth 13.32 Aug-01 2.50%

(Source: Valueresearchonline.com)

February 2010