The proposal certainly did not go down well with investors as seen in the sell-off on Friday, February 2, 2018. The S&P BSE Sensex tanked by 840 points or nearly 2.50% to 35,067. The S&P BSE SmallCap extended the losses further by nearly 5%, while the S&P BSE MidCap Index dropped about 4%.

Retail investors, who over the past couple of years were opening up to the equity market, are wondering how to approach mutual fund investments in the present conditions.

Over the past few years, fund houses and their distributors have aggressively pushed balanced funds luring investors to the dividend option, given the tax-free status at the time. Not surprising, the corpus of balanced funds have burgeoned out of size. Assets managed by balanced funds grew nearly 8 times to Rs 1.35 lakh crore from 0.17 lakh crore over the past five years as on September 2017.

Now, dividends too, will be taxed at a rate of 10%.

Can the policy makers imagine the investors' plight?

Investors, like you, who have religiously putting aside money for their long-term goals expecting tax-free returns, will suddenly have to bear the brunt of parting away with 10% of those gains to the government.

Senior citizens who have invested in the dividend plan of equity-oriented mutual funds to create a steady flow of tax-free income will now earn a 10% lower income.

This is yet another disruption for mutual fund investors, after the same government modified the LTCG tax rules for non-equity schemes.

In the Union Budget 2014-15, when the BJP government came to power, the holding period for non-equity mutual fund investments to qualify as long-term capital gains was increased to three years from one year. Along with this, the tax rate of 10% without indexation was withdrawn. Thus, the LTCG tax remained 20% with indexation.

Post-implementation, Fixed Maturity Plans (FMPs) of debt mutual funds went out of flavour. As did Monthly Income Plans (MIPs) and other hybrid debt-oriented schemes.

To retain investors, fund houses began promoting equity-oriented schemes such as Arbitrage Funds and Equity Savings Funds as a low risk investment option, which enjoyed a tax-free status after a holding period of one year.

As the investors' interest grew towards equity, the dividend plans of balanced funds too were aggressively promoted as an option to earn a steady flow of monthly income.

Now four years later, Budget 2018 will create another disruption.

Before you invest in an equity mutual fund scheme, you will need to take in to account the tax implications.

How does the new LTCG tax norms impact your returns in equity oriented funds?

PersonalFN takes a look…

Longer the holding period, the better

Open-ended equity diversified funds have been able to generate returns of about 12% to 14% compounded over the long term of 5-7 years or more. Investors who have enjoyed these double-digit gains will now have to part 10% as Long Term Capital Gain Tax (LTCG) to the government on gains over Rs 1 lakh (without indexation benefit).

If the gains over a period of 12 months are below the exemption limit of Rs 1 lakh, there’s no question of LTCG tax. However, if the gains are greater than the exemption limit, it would have bearing on the post-tax returns clocked.

Impact Of Holding Period On Post-tax Returns

	1 Year	3 Years	5 Years	10 Years
Investment Period (Years)	1	3	5	10
Investment Date	31-Oct-17	31-Oct-17	31-Oct-17	31-Oct-17
CAGR	12%	12%	12%	12%
Investment Amount (Rs)	200,000	200,000	200,000	200,000
Value as on 31-Jan-2018	206,000	206,000	206,000	206,000
Sale Value At End of Period	224,000	280,986	352,468	621,170
Long Term Capital Gains (C-B)	18,000	74,986	146,468	415,170
Exemption (Upto Rs 1 Lakh)	18,000	74,986	100,000	100,000
Taxable Long Term Capital Gains (E-D)	0	0	46,468	315,170
LTCG Tax @10% (10% of F)	0	0	4,647	31,517
Post Tax Gains (C-A-G)	24,000	80,986	147,822	389,653
Post-Tax CAGR	12.00%	11.99%	11.70%	11.41%

(Source:PersonalFN Research)

Nevertheless, a point to note is, the post-tax returns are still handsome double-digits (over 11% CAGR) to counter inflation, provided you select mutual funds carefully and set realistic post-tax return expectations.

Moreover, if you stay invested for the long-term, power of compounding can work to your advantage enabling you to earn a higher return.  

Thus, have the best mutual fund schemes and avoid churning your equity mutual fund very often.

Thus, you should avoid churning your equity mutual fund very often.

Adjust your financial plan accordingly

As seen in the table above, the post-tax return differs with the holding period. Do take this into consideration to readjust existing financial plans and when setting up new financial plans. Keep in mind, the rate of return assumptions you make will vary.

For example, if you have assumed a pre-tax return of 12% CAGR over 5-years, the post-tax return works out to 11.70%. If you assume a return of 15% pre-tax, the post-tax return will work out to 14.44%. And say, if the mutual fund schemes you choose do not perform, the post-tax returns will be lower. 

Make The Right Post-tax Return Assumption

		5 Years	5 Years	5 Years	5 Years
	Investment Period (Years)	5	5	5	5
	Investment Date	31-Oct-17	31-Oct-17	31-Oct-17	31-Oct-17
	CAGR	6%	9%	12%	15%
A	Investment Amount (Rs)	200,000	200,000	200,000	200,000
B	Value as on 31-Jan-2018	203,000	204,500	206,000	207,500
C	Sale Value At End of Period	267,645	307,725	352,468	402,271
D	Long Term Capital Gains (C-B)	64,645	103,225	146,468	194,771
E	Exemption (Upto Rs 1 Lakh)	64,645	100,000	100,000	100,000
F	Taxable Long Term Capital Gains (E-D)	0	3,225	46,468/td>	94,771
G	LTCG Tax @10% (10% of F)	0	322	4,647	9,477
H	Post Tax Gains (C-A-G)	67,645	107,402	147,822	192,794
	Post-Tax CAGR	6.00%	8.97%	11.70%	14.44%

(Source:PersonalFN Research)

Impact on existing STPs and SWPs

If you have setup Systematic Withdrawal Plans or Systematic Transfer Plans, from an equity fund to your bank account or other mutual funds, now is the time to review them.

The systematic redemptions or switches will come under the tax net after March 31, 2018. You may want to continue existing SWPs or STPs only if it is absolutely necessary. In all other cases, do calculate the tax impact when continuing ongoing transfers.

Growth option now has an added advantage over Dividend options

PersonalFN has never been in favour or the dividend option of mutual funds. More so, after the implementation of a Dividend Distribution Tax (DDT).

If your goal is to grow your wealth, choosing the dividend option will end up eating away the accumulated profit at regular intervals. This will have an adverse impact on your path to wealth creation, as your profits will not be reinvested ––particularly in case of a dividend pay-out option.

Hence, if you are not seeking regular income, it will be best to opt for the growth option. Dividends are often touted to be a benefit as it is tax-free income; however, dividend pay-outs get in the way compounding.

Choose the right mutual fund

Over the past 3-4 years, investors have flocked to arbitrage and equity savings schemes given the tax-free returns on a holding period of over 1 year. However, this has now changed.

Unlike debt schemes or rather non-equity schemes, Arbitrage Funds or Equity Saving Funds and other Aggressive Hybrid Funds will not enjoy the benefit of indexation on the long-term capital gains. Hence, the post-tax returns may work out to be lower for holding periods of three years or more. The LTCG tax for non-equity schemes is 20% with indexation. Here, long term is defined as a period of 36 months.

In addition, many may contemplate whether to invest in tax-saving Equity Linked Savings Schemes (ELSSs) or not. Especially as other tax saving product enjoy an Exempt-Exempt-Exempt status. However, even with the tax implications, the post-tax returns of ELSS are still attractive. Yes, you may lose out on additional returns, but you will still be better off than investing in other fixed income products.

Therefore, given the wealth creation potential of equity. Equity diversified funds are still the best mutual funds for you to generate long-term wealth.

So, review your mutual fund portfolio regularly and stick to your financial plan. The new tax laws should warrant only a few adjustments to your portfolio.  If you are unsure about how to restructure your portfolio in the best way, do consult your investment consultant/advisor.

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Editor's note: Are you confused with the present market conditions? Will the market go up or down from here? Should you invest at all? If yes, how? Which mutual fund schemes to invest? If such questions are lingering in your mind, subscribe to PersonalFN’s latest exclusive report: Top 5 Equity Funds To Invest In 2018. This exclusive report has been created keeping the Investment Scenario IN 2018 in mind. If you have a question, “Which equity funds to invest in now ––under the current market conditions?” This report is the answer to your question. Subscribe now!

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ramesh.taneja@gmail.com Feb 15, 2018 Please mail this useful write up

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