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Personal Finance: Fiscal Fitness

With the norms laid out by FM Jaitley, investors will have to rethink their investment strategies

Photo Credit : Shutterstock


Much to the chagrin of salaried taxpayers, the Union Budget 2018 left direct tax slabs unchanged. The pivotal annual event also went on to rattle both the debt and equity markets, with the Nifty retracing its recent impressive rally in a matter of a week, and 10-year yields spiking another 20-30 basis points. Clearly, the Finance Minister’s most contentious move was to levy a tax on long term capital gains (LTCG) booked on equity shares and equity-oriented mutual funds, which were hitherto tax free. Furthermore, a dividend distribution tax of 10 per cent has been proposed on equity mutual fund dividends, which also enjoyed a tax-free status until now.

Reason to Worry?
Chenthil R. Iyer, founder and chief strategist of Horus Financial Consultants, believes that the decision to tax LTCG was a bit premature, as retail participation in the equity markets was just beginning to gather steam. However, Iyer believes that the minor drop in tax efficiency should have no bearing on strategic asset allocation decisions. “An intelligent investor should not be affected by this move. The biggest financial loss is nothing but the money we never made! So, not participating in the equity market because of LTCG tax, will be penny-wise pound-foolish,” says Iyer.

Experts are not too worried about the recent fall in stock prices, either. “One needs to gain some perspective on this “correction”. Markets are still higher than where they were one month ago; and from their peak at the end of January, have fallen less than 6 per cent,” says Rajiv Shastri, ED & CEO, Essel Mutual Fund. “Movements of this magnitude should not cause any change in investor behavior under normal circumstances”,  he adds.

Shastri is of the view that investors who jumped aboard equities in 2017 with misplaced expectations of linear short-term returns are in for some pain now. “Now that market volatility indicators are back to normal levels from the abnormally low levels, equity markets will start behaving normally again and move in both directions. This will challenge the more mercurial investors, unless they change their expectations and beliefs,” he said.

Switching from Dividend to Growth?

Though LTCG of up to Rs 1 lakh in a fiscal year have been exempted from taxes, equity mutual fund dividends will now be taxed right off the bat — irrespective of the quantum earned by an investor in a year. Resultantly, there is a case in point for mutual fund investors to switch their money out of dividend options, and into growth options with immediate effect. Periodic income requirements, if any, may be fulfilled by redeeming funds from them as and when needed.

“Investors relying on dividends from equity funds such as balanced funds, would have to reconsider their investment strategies. In the present scheme of things, the growth option would be more suitable when compared to the dividend option,”  says Archit Gupta, Founder & CEO, ClearTax.

Fixed Income: Time to Lock-in the High Yields, or Wait and Watch?
There was no good news in store for already hard-pressed debt mutual fund investors, who had a poor run for most of 2017. Rising yields had already severely impinged upon most fixed income fund returns in the past year, with some delivering flat or even negative returns in this period. The government’s decision to raise its fiscal deficit target in the recent Budget sent yields spiralling even higher. The question many debt fund investors ask is: Should they continue to focus on accrual funds, or is it time to judiciously expose their portfolios to higher duration funds?

Mahendra Jajoo, Head, Fixed Income, Mirae Asset AMC believes that the macro environment, both globally and domestically continue to be challenging for fixed income markets. “Domestically, inflation is at 5.21 per cent, already above RBI’s projection, and is expected to inch-up further in coming months,” says Jajoo. “Higher crude prices continue to pose their own challenges. An increased supply of bonds at a time when appetite from banks is poor, has resulted in cancellation of a few auctions recently. The early estimates on monsoon, which could affect food prices, shall be available not until April. As such, bond yields may continue to face pressure for the time being,” he adds.

Having said that, Jajoo also believes that the bond market is already pricing in a very negative outlook — and this may therefore be an appropriate time to begin a gradual exposure to current yield levels. Indeed, investors who have understood the dynamics of debt markets could start planning an allocation of 25-40 per cent of their debt investments to higher duration, longer term debt funds now. “However, there could be continued volatility in the near term,” says Jajoo. A prudent approach would be to take an exposure to longer-term debt funds via six-month SIPs and STPs from shorter term debt funds, instead of investing lump sums.

Time for ULIPs? Not Quite 
The life insurance community is already clamouring for switches from equity mutual funds to ULIPs, whose proceeds still enjoy a tax-free status. Experts are cautioning investors against this move, though. “ULIPs may look lucrative. However, their multiple costs and inflexibility can wreak havoc on the long-term performance of these investments”, said Iyer, adding that exiting a ULIP can be a very costly affair. “Tax efficiency should not be the primary decision factor for making an investment,” he concluded.