Mutual funds: Have moderate risk appetite for investing into equity funds

By: | Updated: March 29, 2016 2:15 AM

Besides tax planning, other important aspects about investing in ELSS that you should consider are your risk appetite and the investment horizon

For the last two months, I have seen some recovery in gold ETF? Given the volatility in gold ETF, should I redeem my units?
—Anupam Mishra

Historically, gold has acted as a good hedge against inflation and financial market volatility. During periods of economic or financial market crisis, gold tends to perform well and is considered a safe haven vis-à-vis other asset classes like equity and fixed income.

For instance, during the period from early 2008 to 2011 when equity markets witnessed significant volatility gold generated an annualised return of 26.8% (3 year). But unlike equity and debt which typically pay out either interest or dividends, gold isn’t an income generating asset.

Further, a long term analysis of the performance of various asset classes indicates that gold under-performs equity. Over a 25-year period starting 1990, Indian equities have generated an annualised return of 15% versus 10% for INR gold. Overall, gold acts as a good portfolio diversifier but due to its performance and income related characteristics outlined above, allocation can be limited to 5% to 10% of one’s portfolio. In case the allocation to gold in your portfolio is around these levels, you can continue to hold the units.

For tax on dividends received above R10 lakh a year introduced in this year’s budget, will I have to club all dividends received from my mutual funds, direct stocks, bonds and pay the tax if it is more than R10 lakh?
—Pramod Singh

As proposed in the Union Budget FY 2016-17, in addition to the dividend distribution tax (or DDT) paid by the companies, tax at the rate of 10% of gross amount of dividend will be payable by the recipients, that is, individuals, HUFs and firms receiving dividend in excess of R10 lakh per annum. The proposed tax would be applicable only on dividends received on shares and doesn’t include mutual funds and bonds.

I have lost money in ELSS invested last year. For tax-saving this year, should I still invest in ELSS or wait for next year for the market to recover?
—Deepak Shetty

Besides tax planning, other important aspects about investing in ELSS that you should consider are your risk appetite and the investment horizon. ELSS funds invest in equities, which tend to generate attractive returns over the longer term (3 to 5 years and above) but these returns can fluctuate over the short term. For example, ELSS funds have generated annualised returns of 17% and 12% over the last 3 years and 5 years respectively, on an average.

But this has been accompanied by a few periods of negative returns. Historically, the probability of generating negative returns from ELSS funds has been 6.2%, 0.83% and 0% over 3 year, 5 year and 7-year holding periods respectively over the last 15 years.

In other words, out of a total of 145 periods of 3 years each, over the last 15 years there were 9 periods in which the category on an average generated a negative return. As the investment horizon increased to 5 years, the number of periods with negative returns reduced to 1 out of 121 periods.

Hence, one should have at least a moderate risk appetite while considering investments into any equity fund including ELSSs.

I am 50 years old and looking for pension schemes with equity exposure in mutual funds where I can invest for 10 years and get a monthly payout once I  am 60 years. I do not want any insurance-related annuity schemes. How can I do that in mutual funds, please suggest.
—Sudeep Manoj

There are a few pension or retirement funds available on the mutual fund platform. Some of these funds also provide tax benefits under Section 80C of the IT Act with a deduction of up to R1.5 lakh per annum available on the amount invested in such funds. These funds invest in a mix of equity and debt instruments in varying proportions ranging from 30% to 100% in equity and the remainder in debt, during the accumulation or pre-retirement phase and typically up to 40% in equity during the post-retirement or withdrawal phase.

Some funds also offer separate investment options for the pre-retirement and post-retirement phases with varying levels of equity investment. After retirement (at the age 58 to 65 years), one can withdraw from the scheme using a Systematic Withdrawal Plan (or SWP), either at a monthly, quarterly, semi-annual or annual frequency. The SWP amount can be fixed at the time of retirement and would continue till the investment corpus is exhausted. Since the corpus is invested in market linked instruments including equity and debt, it could fluctuate based on the market value of the underlying holdings.

The writer is director, Investment Advisory, Morningstar Investment Adviser (India)

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