How to realign your MF portfolio

In several of my earlier blog posts, I have covered practically all aspects of MF investments and you should be in good shape if you are starting off to create a MF portfolio from scratch. However, as some readers reminded me, most of us are already having an MF portfolio and some of us are having SIP investments in several funds. Different portfolios for different goals can also lead to people holding more funds than is either necessary or desirable.

The good thing is you can realign your portfolio and get into a logical allocation quite easily. As I have covered the basic logic of my suggested portfolio structure and SIP / one time investments I will not repeat them in this post. You can read these posts here and here. In this post I will outline a simple method by which you can realign your portfolio.

Step 1 : Be clear about your intended portfolio structure:

  • For the long term you need just 4 funds – a large cap fund, a mid cap fund, a multi cap fund and a small cap fund. If you want to hedge your bets you can add an International fund, mainly US based.
  • You do not need to have any Balanced funds, Sector funds or Thematic funds.
  • Always go for Direct funds as the lower cost will enhance your returns significantly over the long run.
  • Remember you need only 1 portfolio for all your goals and not a separate one for each goal.

Step 2: Map your current portfolio to the above portfolio structure:

  • Check if the funds you hold are aligned to the above portfolio. If not then discard them logically from your portfolio.
  • For the aligned funds, check if they are suitable for your portfolio. Read about how to select funds here. If any of the funds are not suitable then discard these.
  • We will decide what to do with the discarded funds later on.

Step 3: Get to your new portfolio structure:

  • Take whatever you have got from step 2 and add other funds based on the portfolio structure and the selection method.
  • Now you have s set of 4-5 funds in your portfolio. In all of these your investment value is either zero or equal to the earlier investment, in case you are retaining any of your earlier funds.

Step 4: Decide on your investment amount per month:

  • To begin with use a SIP calculator to check what should be your monthly investment. You can take any rate of return between 10 and 15 % based on your comfort level.
  • You can start by putting equal amounts in all 4-5 funds. However, if you prefer a fund type over another then you can tweak with the monthly SIP amounts. It does not matter a great deal, as long as you have got the portfolio correct.
  • Increase the SIP amount every year based on the availability of extra money to invest.

Step 5: Redeem the discarded funds at the right time and invest into your new portfolio:

  • Redeem your discarded funds at a time when it seems right. There is no exact formula but you can observe the trends and take a call. For example, if the Nifty reaches a level between 10800 and 11000 now it will be a good time to redeem the funds that you do not want to be in any more.
  • There is no rush in this, your investments are growing even if you have discarded the funds logically from your portfolio. Once you have redeemed the funds be in cash or keep the money in a liquid fund, till it is time to buy.
  • Invest the above money through one time purchases of the funds in your new portfolio at an appropriate time.

As you can see from here realignment of the portfolio is a fairly simple exercise, once you are clear about the mechanism. If you feel that you need to do it, the right time to start is NOW. In case you are not invested in the right funds then any further investment in them is completely senseless.

In case you have any questions on realigning your portfolio, comment on this post and I will be happy to clarify.

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Equity MF dividends – the whole story

After my last few posts I am getting a lot of enquiries from people as to what they should do about their schemes with dividend options now. Many are unclear about the tax and how will it be treated in their hands. In this post I wanted to demystify the dividends from equity MF and suggest ways about how you can deal with them.

To begin with let us understand how a Dividend option of an MF scheme is different from a stock. Any company, whose stock you hold, will pay you dividends from the profits that it makes in a quarter or year. Based on the amount of dividend paid the stock price will normally fall initially but may well rise later. In the case of a Dividend paying MF scheme, the dividends are being paid out from the assets held by the scheme. As some of these assets are liquidated the NAV of the fund will necessarily fall after a dividend is declared. Yes, it may rise again if the stocks in the MF scheme portfolio do well but it is fundamentally different from the stocks.

Let us now examine the taxation aspect of dividends before and after the budget. When a company declared dividends it was out of the profits where taxes have already been paid by the company. Therefore the dividend that investors received was tax free. In the case of equity MF schemes too they did not pay any holding tax and whatever dividend the investor got was again tax free in their hands. After the budget the situation remains the same for stocks but has definitely changed for MF schemes. These will now have to hold a tax of 10 % before distributing the dividends to the investors. This is the Dividend Distribution Tax ( DDT ) newly introduced in this budget. Remember that Debt funds always had a DDT of more than 28 % earlier and continue to do so.

How does this change things for you now? Well, for one you will have lower dividends for your equity MF schemes due to the DDT. Typically this will be 10 % lower. It will continue to be tax free in your hands. For example, I had invested 2 lacs in the dividend option of a  Value Fund series NFO from ICICI. Every year I would get 15000 Rs dividend from this investment. All things remaining equal, the value of this dividend after the new DDT rule will be 13500. If an investor is depending on these dividends for passive income then he will need to get this shortfall from somewhere else.

In general Dividend option is not a good idea for equity MF now – note that companies pay tax on their earnings and this is reflected in the stock price and also the level of dividend they pay to their investors. Equity MF are investing in these companies and are again paying DDT. Finally when you redeem these investments you will again be charged LTCG tax at 10 %. It will be much better to just deal with the Growth option where you just pay LTCG tax when you redeem your units.

Let us now look at some classes of investors who are currently invested in these MF schemes and what they should do about it:-

  • If you are in the active income earning stage of your life, there is no logic in having Dividend options for your MF schemes. Change all of them to growth. Even if you need the money you will be better off just redeeming some units as and when you need to do so.
  • If you had chosen this option in order to do some explicit profit booking by the Fund houses then your concept was wrong. Fund Managers will churn their portfolios as and when required and these benefits will reflect in the NAV of your scheme. There is really no need to invest in the Dividend option for it. You should also change it to Growth option.
  • People in the retired or FI state may have invested in these schemes as a means of getting regular income. Some Balanced funds have schemes where they distribute a monthly dividend. Note that all of these are subject to DDT now – so either you will get less dividend in your hands or the fund NAV will fall more if the same dividend is to be maintained.

Except in the last case, where some people may want a hassle free receipt of dividend as compared to redeeming units on their own, there is really no point in Dividend options of MF schemes now. In fact, with online redeeming being possible, anyone can sell units of MF schemes rather easily and I will definitely recommend that.

Short conclusion to the story – change all your MF schemes to Growth option right now!!

How should you invest in Mutual funds now?

Whichever way you want to look at it, the Finance minister has definitely sent all MF investors in a tizzy with his LTCG taxation on equity. This was always likely to happen and many investors, used to a diet of high growth with no taxes to account for, are shocked and wondering what they should do with their existing investments and new ones. I will give you a very clear recipe in this post that you can follow effectively.

To begin with, the popularity of MF investment through SIP were due to two main factors. The first was the marketing skills of the Fund houses and the awareness on inflation created by the myriad financial blogs and Facebook groups. Investors realised that traditional investments such as Fixed deposits, PPF, LIC schemes, Bonds etc would not keep pace with inflation and they had to look at equity to a certain extent for meeting their important life goals. For these set of people, investing in MF seemed like a less risky idea as compared to direct equity. The successful model of sales and distribution put in place by Fund houses have ensured that they have mopped up amounts nearing 1 lac crore annually.

However, there was another reason which many are not cognisant about. When the Finance minister change the LTCG indexation benefits from 1 year to 3 years in his first budget, he actively pushed people away from schemes like Fixed Maturity Plans. With declining interest rates, longer holding period and reduced inflation unfavourably affecting the indexation benefits, suddenly Debt funds were really not a good option for people wanting to park their money in short term. The Fund houses responded by coming up with schemes like Arbitrage funds and Equity Savings funds where the safety was greater than pure equity funds, returns were better than Debt funds and the holding period needed to be one year only for getting tax exempt returns. Many Fund houses even offered monthly dividend on Balanced MF schemes which were particularly suited to retired people, in search of a regular monthly income.

Thanks to the FM all this is a matter of the past now. Given the current situation, how should you deal with your MF investments? I have put together some simple guidelines for different types of investors, that will give you a clear road map of what you should do:-

  • If you are an investor whose goals are still some time off:-
    • Keep investing in your SIP as before but add 10 % to the amount for taking care of the eventual taxation.
    • Make sure you have only Growth option schemes in your portfolio as it makes little sense to get dividends now, unless you really need it.
    • If you have set up STP for your monthly flows into SIP, evaluate if this makes sense. You will be taxed for selling the funds now.
    • As churning is detrimental to your returns now, make sure you select the right MF schemes and stick to them for the long term. Yes, you still need to review etc but change the scheme only when really needed.
    • The longer you hold your investments the better it will be for you. Redeem only when you actually need the money, not otherwise.
  • If you are an investor with major goals coming up:-
    • Check out if you can meet your goals through existing Debt investments and keep your MF investments running for a longer term.
    • If this does not work, redeem from your MF schemes only the amount you need right now for the goal. For example if your child’s college fees are 20 lacs in 4 years and 5 lacs per year, then redeem only to the extent of 5 lacs.
    • If the markets manage to go up beyond the Jan 31st levels within March ( this is unlikely, but you never know ), redeem your MF units to the extent of the money you need for your goals in the next Financial year.
    • As before, avoid Dividend options and if you have any MF schemes with these then change it to Growth.
  • If you are retired or in need of regular passive income in your Financially independent state:-
    • If you had set up Arbitrage funds, Equity Savings funds or invested in Dividend option of some close ended equity NFO’s check your taxation impact and decide if it is making sense.
    • If you are a senior citizen take advantage of the 50000 Rs interest exemption and the LIC scheme with 8 % interest.
    • Rearrange your MF investments so that you only get the Dividend amounts that you need regularly. For any sudden or unplanned expenditure, you can always redeem your MF units within a day.
    • Do not churn your MF investments needlessly, you will end up paying more taxes by doing this.
    • Finally, even in the new tax regime, do not give up on equity MF. It is important for you to remain invested as a hedge to inflation.

As you can see from above, there is a need to take stock and possible reorganise your MF portfolio. However equity as an asset class and Mutual funds as an investment vehicle are still the best in the business and you should continue to bet on them.

If you have any specific queries I will be happy to answer them through my Blog or through the two Facebook groups that I run.


MF investments and LTCG tax – the real impact

With a lot of heat and dust about the LTCG taxation on equities one aspect of it, namely, the real impact of the tax on an investor’s long term return have largely got very little attention. I was made aware of it through an article by Dhirendra Kumar of Value Research Online and largely agree with what he has said. As many of the investors may have missed out on this, let me try and explain it in this post.

Now, we all know that it is possible for equity to grow at a rate of 12-15 % in a long term period of 10 years and more. Of course, the growth in equity is non-linear, meaning you may well grow 30 % in a year like 2017 and even have negative growth as in 2008 and 2011 etc. If we look deeper into the growth of our MF investments we will see there are clearly 2 parts to it – first is the inflation prevalent in the economy and the second is the real return you get on your investment. For example, if your MF investments have grown by 15 % and inflation during this period was 8 % then your real return is 7 %. In general, your real return can exceed 10 % in a good year for the markets and will be in the range of 4-8 % in other years. Again, if the markets turn negative or are mostly sideways in a year then your real returns may well be negative.

With this backdrop, we will take an example to understand the impact of the recently introduced LTCG tax on equities on your MF returns:

  • An investor starts investing through SIP in one of the popular MF schemes from April 1st 2018. Let us say the amount is 20000 and he wants to do it for 15 years.
  • At 12 % annual returns he will get about 1 crore, which he plans to use for his daughter’s higher education.
  • His overall LTCG will be to the tune of 64 lacs and the tax thereon will be 6.4 lacs.
  • Now if we assume that the inflation component is 6 % and the real returns are also 6 % then the real returns are to the tune of 32 lacs.
  • In effect you are paying 6.4 lacs tax on a 32 lac real gain – this comes to 20 % and not 10 % as most of us are given to understand.
  • This situation could have been corrected if indexation was allowed but that has not been done in the case of LTCG on equities.
  • The 1 lac exemption etc has very little meaning for people looking at a large goal as it will be an insignificant part as compared to the goal amount.
  • In simple terms you are being taxed on inflation too, which is grossly unfair !!

In terms of the goal itself, you will need to increase your monthly SIP amount by 1281 Rs so that you are having the required goal amount after taxation.

So what can you do from your end to see that you minimise the taxes at least? Well, for one, you can spread the redeeming over the years of college so that the impact will be shared over 4 years or so. This will not affect the total tax outgo but you will feel better that your tax payment at one time does not appear so horrendous.

I hope the intelligent readers would have understood the real dangers here. Even if your real return is much lower, say 10 % you still pay a lot of tax. For the above example at 10 % returns your LTCG is 47 lacs and you pay tax of 4.7 lacs. As a percentage of real return you are now talking of well over 30 %. If your real returns are even lower if the market tanks in that year, then the tax paid as a percentage will be even higher.

The conclusion is a simple one – by not allowing for indexation the FM has really dealt a body blow to long term investors who have been investing seriously over the last several years and have played a stellar role in the success of our stock markets.

What strategies can you adopt for your investments? I will take this up in another post.

LTCG tax on equities – How to calculate?

Since I have started writing this blog there has been three budgets and I normally get a lot of queries after every budget. In this budget, understandably the maximum number of queries have been in the tax treatment of equities, where LTCG has been taxed at the rate of 10 %. I was thinking of doing a post on this but a CBDT circular clarifying the different scenarios has made my task easier.

As I do not believe in reinventing the wheel, let me just reproduce here what the circular says. I am doing this so that people reading my blog have easy access to it:-

The computation of long-term capital gains in different scenarios is illustrated as under‑

Scenario 1 — An equity share is acquired on 1st of January, 2017 at Rs. 100, its fair market value is Rs. 200 on 31st of January, 2018 and it is sold on 1st of April, 2018 at Rs. 250.

As the actual cost of acquisition is less than the fair market value as on 31st of January, 2018, the fair market value of Rs. 200 will be taken as the cost of acquisition and the long-term capital gain will be Rs. 50 (Rs. 250 — Rs. 200).

Scenario 2 —An equity share is acquired on 1st of January, 2017 at Rs. 100, its fair market value is Rs. 200 on 31st of January, 2018 and it is sold on 1st of April, 2018 at Rs. 150.

In this case, the actual cost of acquisition is less than the fair market value as on 31stof January, 2018. However, the sale value is also less than the fair market value as on 31st of January, 2018. Accordingly, the sale value of Rs. 150 will be taken as the cost of acquisition and the long-term capital gain will be NIL (Rs. 150 — Rs. 150).

Scenario 3 —An equity share is acquired on 1st of January, 2017 at Rs. 100, its fair market value is Rs. 50 on 31st of January, 2018 and it is sold on 1st of April, 2018 at Rs. 150.

In this case, the fair market value as on 31st of January, 2018 is less than the actual cost of acquisition, and therefore, the actual cost of Rs. 100 will be taken as actual cost of acquisition and the long-term capital gain will be Rs. 50 (Rs. 150— Rs. 100).

Scenario 4 — An equity share is acquired on 1st of January, 2017 at Rs. 100, its fair market value is Rs. 200 on 31st of January, 2018 and it is sold on 1st of April, 2018 at Rs. 50.

In this case, the actual cost of acquisition is less than the fair market value as on 31stJanuary, 2018. The sale value is less than the fair market value as on 31st of January, 2018 and also the actual cost of acquisition. Therefore, the actual cost of Rs. 100 will be taken as the cost of acquisition in this case. Hence, the long-term capital loss will be Rs. 50 (Rs. 50 — Rs. 100) in this case.

I hope with this all the readers would have got a very clear idea on how the tax is to be calculated. However, the more serious issue is the real impact of the tax on your investments you have been making for the long term.

The news on that front is unfortunately not a good one – I will explain in the next post.

Nifty outlook for 2018 – Troubled but with some hope

When I look at what has happened in 2018 with the Nifty so far, I definitely get a sense of deja vu. A decade back in 2008, the Indian markets were flying high with the Nifty having crossed 6000 in January. At that time too, there were global rumblings on the sub-prime crisis, though the Indian context was not really an issue. We all know from history what happened. We went into a sharp and brutal correction initially, followed by years of listless performance till 2014. What many investors are worried of now is whether there is a chance of history repeating itself and , more pertinently, what is likely to happen in 2018. Let me try and share my observations in this post.

To begin with, let us understand one major difference between 2008 and 2018. In the former year, Indian markets had a very strong dependence on FII money and they could crash the market by pulling out whenever they had any inkling of bad news. Over the years, with the domestic retail money coming into the market through SIP in Mutual funds, the dependence on FII money has reduced a lot. As of now we really do not know how the domestic retail investors will behave when they see sharp cuts in the markets. In the past few years, they have not panicked when there were some cuts but what we are looking at now is going to be more serious. My own take is this – given the increased knowledge about goal setting and financial planning, it is unlikely that there will be panic on a large scale. Yes, some people will book profits and take out money fearing deeper crash, others will lower their SIP contributions but these will not be impacting the markets in a serious way.

So what are the factors that will play a greater role? As usual one will have to look at performance of earning as well as the news driven sentiment in the markets. I can think of the following issues for 2018:-

  • The society and the polity are clearly divided along serious fault lines in India. The opposition will oppose everything and even try to manipulate to have any chances, the government is in no mood to listen to any advise, even if it is good one.
  • The impact of the budget will be important for elections in 2018. If BJP wins in Karnataka along with some North Eastern states they will be tempted to call for an early election. I somehow think this will not happen though and the General elections will be held in 2019 only.
  • The elections will definitely be fought along 2 large blocks in 2019. Throughout 2018, the election results for the states will have a high impact on the markets.
  • Budget implementations, especially on the GST and welfare schemes will have a positive impact on the markets.
  • Earning growth is clearly starting to happen now. If this goes well in the next few quarters, the Nifty will shrug off the current panic and move forward. However, this will not be the year of decisive growth, it will be incremental at best.

With these factors playing out, how do I see the Nifty move through 2018? Well, to start with, I think it will go down to 10000 or even 9500 over the next 2 months. If the yearly results are good and some of the election results and GST figures show BJP in a good light, recovery will start slowly. Even then, any decisive move is only likely if the BJP wins the Karnataka elections – this looks quite difficult as of now. In the absence of such a win, this will be slow going year for the Nifty, waiting for triggers in the form of quarterly results. Assuming that the current trend of earning improvement continues and there is a good monsoon as widely predicted, Nifty will probably recover at a faster pace in the latter part of the year. Here are my predictions for the Nifty then:-

  • 9500 by March end 
  • 8500 by May end if BJP loses Karnataka to Congress
  • 9000 by July end with good monsoons, GST collections and Q1 results
  • 10000 by October end with good agriculture news, welfare scheme implementations and earning growth for H1
  • 11000 by December end if BJP wins at least 2 out of the 3 state polls in Rajasthan, MP and Chattisgarh.

In a pessimistic scenario many things can go wrong – Oil prices can continue to rise, inflation can get out of control, Monsoons may play truant, earning growth may be muted and BJP may lose most elections. In such a scenario Nifty may well end the year 2018 languishing at around 9000 range.

On the balance though, I think we will be getting back to 11000 though the route will be rather tortuous as I have described in the post.

The impact of budget on your investments

When you are in the middle of a storm it is difficult to stay calm. The immediate aftermath of the budget yesterday has been a sharp fall in the markets – the fall is significant for the Sensex and the Nifty and brutal for the mid cap and the small cap indices. I thought of writing this post about the overall impact of the budget on your investments but it will probably be a good idea to start with the markets first.

Now as any of us who have been in the markets for some time will know, the markets do not like surprises. In the budget of yesterday, there were 2 elements which were not really surprises, yet the markets were hoping against hope that they will not take place. The first is the fiscal deficit figure whose importance is really in how the world views us financially. Not only have we not met the projected 3.2 % but, what is far worse, we are pegging the next year target too at 3.5 %. The financial discipline which was the hallmark of the last few budgets seem to be slipping. The second is of course taxing of LTCG for equities. While this had to happen some time, the markets are clearly shocked at it being done now and in not doing away with STT. Out of the two factors, the first will spook the FII’s and the second will be more of a problem for domestic investors. It was therefore expected that the markets will fall today, but the extent of the fall has been shocking.

Let us take a look at the LTCG part in closer detail. There are several issues in it which have not been understood well. By and large, people investing in stock markets are the relatively better off people in our society as compared to those who do not. It will be unfair not to tax LTCG at all, given the increasing income disparities we are seeing in society today. So if the government had to run welfare schemes such as Ujala and the Health scheme the money had to come from somewhere. This was the obvious choice and the other was raising the cess from 3 % to 4 %. I am a little surprised that LTCG period has only been kept at 1 year. This along with the little difference from the STCG rate will mean that there is really no incentive for holding equity long term.

Let us now look at what it means for investors in tangible terms:-

  • All your gains made so far are well protected as the price on 31st Jan, 2018 will be taken as the cost price. Though you will be charged for future gains from this price, your current valuation of portfolio is protected.
  • If you sell your stocks and MF in the next FY, it will be possible to structure the sale so as to minimise the taxes. For example every one of us will have some stocks in our portfolio which lose heavily. This will be the time to square off these losses with the gainers so that you do not have to pay much taxes. 
  • As far as MF goes most of us are doing it for some long term goal and we can just continue to do so. Yes, you will pay some taxes on future gains but not on your past ones. Investors doing SIP should simply continue, you may now want to bump up the amount by 10 % to take care of the taxes when you redeem. Note that this is mainly true for the Growth option.
  • If you have chosen the dividend paying option in your MF investments then the DDT will come into place from April. You will now roughly get 10 % less dividend as compared to what you were getting earlier. If this forms part of your passive income then you will need to secure this gap from somewhere else.
  • Indexation not being there is a good thing as you can simply sell it now at any point in time, without worrying about the indexed cost price. In any case, indexation works best with debt products where the returns are linearly unidirectional.

In summary what should your actions be?

  • Clean up your portfolio by selling stocks you do not want to keep, especially if they are losing money. Make sure that your overall gains after squaring off the lasses are not more than 1 lac so that you need not pay any taxes next year.
  • Continue with SIP in your MF investments, look into increasing the monthly outlay to take care of the eventual taxes.
  • Dividend option in MF schemes is a bad idea now. You will be paying DDT twice and again pay taxes on LTCG. Go for the Growth option, if you need money you can simply sell off some units.
  • Rest of your investments in Debt etc can continue as before.

So you will see, there is no real reason to panic at all at an individual level. The markets are doing so as they had gone up a lot and would anyway have corrected. This bad news has given it a reason to do so now. If it was not this it would have been something else.