I have started investing in debt and equity mutual funds. I fall in the Rs 1.5-2 lakh tax slab. Do I still need to pay 15% tax on capital gains?
Dividends and long-term capital gains (holding period of over a year) on equity mutual funds are tax-free. Short-term capital gains from equity funds are taxable at 15% irrespective of your income tax slab.
For individual investors, dividends on non-equity mutual funds, including debt funds, are taxable at 28.84% and short-term capital gains at the investor’s marginal rate of taxation. Long-term capital gains (holding period of over 3 years) from non-equity funds are taxable at 20% with indexation benefit.
Why are gilt funds giving double-digit returns while returns from liquid funds are similar to those from bank fixed deposits? Should I exit the fund category altogether, or is there an issue with my fund house?
Liquid funds have an entirely different risk-return profile compared to gilt funds. Liquid funds invest in short-tenor debt instruments (up to three-month maturity) due to which they carry negligible interest rate risk, i.e., the returns don’t fluctuate with movements in market interest rates. Hence, they tend to generate returns in line with short-term interest rates on other instruments, such as 3-6 month FDs. Due to the low volatility in returns, they suit investors with an investment horizon of 3 to 6 months.
On the other hand, long-term gilt funds typically invest in medium- to long-term government securities (GSecs) due to which their returns are sensitive to interest rate movements. Over the last 12 to 18 months, yields on medium- and long-term GSecs have come down a sharp 1-1.25%, resulting in double-digit returns. The fall in yields has been on account of several factors, including the RBI reducing rates due to easing inflation, stability in the rupee-dollar rate, falling crude prices, etc.
Due to their higher volatility, long-term gilt funds suit investors with a moderate risk appetite and a horizon of 18 to 24 months. Your decision on whether to stay invested in, or exit, liquid funds and invest in gilt funds should be based on due consideration of the above factors.
I have invested in bank stocks such as HDFC Bank, SBI and ICICI Bank and the returns have been mixed. Now, I want to try banking-specific mutual funds for a three-year horizon. What extra gains can I expect?
Sectoral equity funds, such as banking sector funds, do have the potential to generate higher returns than diversified funds but with much higher volatility. Since these funds invest in only a specific sector, the onus of timing — of both entry and exit — lies with the investor unlike in the case of diversified equity funds wherein the fund manager would take these calls. Timing is important because sectors like banking are closely linked to economic and interest rate cycles and their performance varies with changes in these. Consider investing in sectoral funds only if you have a high risk appetite and the ability to time to your entry and exit.
Do I have to give separate KYCs for investing with three fund houses?
No. If KYC has been done once, that is sufficient.
Is it better to invest in SIP index funds for the long term?
The key benefits of investing in index funds include low expense ratios vs actively managed funds, and the fact that they track the broader market effectively. Expense ratios of index funds are 0.3-1% per annum whereas actively managed funds charge 2.25-3%. A higher expense ratio impacts returns over the long term. Actively managed large-cap funds have on average generated an additional return, or alpha over the index, of around 1.5% annualised over the last five years. Over 10 years, returns have been similar to the index’s. Of course, the top-performers within this space have generated higher alpha. On the other hand, small- and mid-cap funds have generated higher alpha of over 7% annualised over five years and 4.5% annualised over 10 years over the mid-cap index. Hence, there is a strong case to consider SIPs in index funds, at least for some part of the large-cap portfolio. Most mutual funds allow SIPs for more than 10 years and one can stay invested for that tenor based on the investment horizon and liquidity needs.
The writer is director, Investment Advisory, Morningstar Investment Adviser (India)
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