1. Investing: Asset allocation

Investing: Asset allocation

Investors should go for a proper asset allocation of equity and debt based on the risk appetite for tax-efficient returns

By: | Updated: March 8, 2016 12:57 PM
Investors should go for a proper asset allocation of equity and debt based on the risk appetite for tax-efficient returns Investors should go for a proper asset allocation of equity and debt based on the risk appetite for tax-efficient returns

While the Budget proposal to tax EPF withdrawals met with widespread criticism, investors who rely only on tax savings for long-term investments may have to change their portfolio allocation, especially those who have opted for higher contribution in Voluntary Provident Fund.

Till now, the 8.8% tax-free returns from the EPF made it the best debt instrument for long-term savings after Public Provident Fund (PPF) at 8.7%, though the annual investment limit in PPF is R1.5 lakh. The income from bank deposits is fully taxable, and so are other small savings schemes like National Savings Certificates and Monthly Income Scheme. However, bank deposits account for 58% of the total financial assets of Indian households, indicating the fact that most investors look at assured returns and safety of the capital. However, each depositor in a bank is insured up to a maximum of Rs1 lakh for both principal and interest in case of a bank failure.

For every private sector salaried employee – there are 3.7 crore EPF subscribers – the very tax structure of EPF till now made it an ideal way to save for long-term goals. Monthly contribution is deducted from the salary and goes into the account, which can be seen online like a bank statement and most importantly, contributions are linked to income – as income grows the contribution grows accordingly. In other words, it an ideal debt systematic investment plan (SIP), like mutual fund, provided the subscriber doesn’t withdraw the corpus at every job change.

Mutual funds & insurance

For higher long-term tax-free returns, analysts suggest investors should look at balanced equity or equity mutual funds. One option is equity-linked savings schemes (ELSSs), which offer the twin-advantage of capital appreciation through investment in stock markets and long-term capital gains tax after one year is nil.

In ELSS, the lock-in period is three years and an investor can invest a minimum of R500 a month through a systematic investment plan. Money is debited automatically from the investor’s bank account through the ECS mandate and units are allocated based on net asset value applicable for the day. ELSS schemes are open-ended, that is, investors can subscribe to the fund any day.

Balance funds of mutual funds are also an ideal tax-saving options as more than 65% of the investment is parked in equity, and the rest to debt. Balanced funds are suitable for investors with a moderate risk profile and investment horizon of over three years.

Returns from equity-oriented funds are tax-free returns if the holding period is greater than a year; otherwise, they are subject to short-term capital gains tax.

Balanced funds are less volatile as it gets the upside by increasing allocation to equity when the markets are declining, and reduces the equity exposure when markets are rising.

Even unit-liked insurance plans of life insurance companies are tax-efficient. They are essentially market-linked insurance scheme that offer tax saving options under section 80C of the Income Tax Act and offer tax-free returns after one year. The lock-in period of Ulips is for five years.

Tax-free bonds

Retail investors looking at lump-sum investment, can earn higher returns in tax-free bonds. In these bonds issued by state-owned companies, while the investor does not get any tax exemption under Section 80C of the Income Tax Act, 1961, the interest accrued is completely tax-free under Section 10(15)(iv)(h). The proceeds from the bonds are invested in infrastructure projects.

Retail investors, which comprise individual investors, Hindu Undivided Family (through Karta) and Non-Resident Indians, can invest up to R10 lakh in each issue.

An individual can invest in more than one company and still be in the retail category. Individual investors investing more than R10 lakh will be classified as high net worth individuals. About 40% of the public issue will be earmarked for retail individual investors. Investors do not have to pay tax on the interest earned on such bonds, which makes them more attractive than other taxable debt instruments and even bank fixed deposits.

Brijesh Damodaran, founder & managing partner of BellWether Advisors LLP, says, investors in India have a bigger exposure to fixed income instruments such as provident fund, debt mutual funds and the evergreen bank fixed deposit compared to equity. “They need to change this and go for proper asset allocation strategy,” he says.

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