Equity savings fund comes with three benefits—growth potential of equity, income opportunity and tax efficiency. It is suitable for those who want to combine the potential for capital appreciation along with regular income and medium market volatility
Investors seeking higher returns than that offered by bank fixed deposits, can invest in equity savings schemes of mutual funds, albeit with some risk. These schemes invest one-third of the amount in fixed income instruments, one-third in equity-related instruments and the rest in arbitrage. For tax treatment, it is treated as an equity fund. Experts say conservative investors who invest in bank fixed deposits should look at equity savings fund as it is tax-efficient and offer higher post-tax returns. It is ideal for investors with moderate risk appetites for medium- to long-term investment objectives.
It is less risky than balanced funds as only one-third of the amount is invested in equity. Equity savings funds became popular after the 2014 Union Budget when the government increased the holding period of debt mutual fund from one year to three years to qualify for long-term capital asset.
Tax efficient investment
For risk-averse investors, equity savings fund has benefits in terms of taxation. While interest earned on bank deposits is taxed at the marginal rate, there is no tax on returns earned from equity savings fund, provided the holding period is more than a year. However, if the units are redeemed before one year, then the investor will have to pay short-term capital gains tax at 15%. Moreover, if an investor prefers to invest in pure debt funds, it will attract both short and long-term capital gains. Short-term gains are added to the investor’s total income and will be taxed according to his slab. And long-term capital gains will be taxed after three years at 20% with indexation. In other words, debt-oriented schemes, such as monthly income plans, will have the same tax treatment as bank or post office fixed deposits.
The arbitrage allocation helps yield stable returns and to be taxed as equity fund. Asset management companies have the expertise in arbitrage to generate low-risk returns. In fact, a 10% net of tax return is far better than a 50% equity portfolio yielding 15% return and 50% debt yielding 6% post tax return.
Less volatile than equity funds
Equity savings funds are less volatile because a large part of the corpus is invested in debt and arbitrage which helps in stabilising returns. Moreover, to reduce volatility and hedge the portfolio, the fund uses derivative strategies. The arbitrage part of the fund looks at the price difference in securities in different segments of the market. Analysts say equity savings fund is suitable for those who want some equity exposure with stability in returns. However, those looking for higher returns with some risk can invest in pure equity funds. Equity savings fund comes with three benefits—growth potential of equity, income opportunity and tax efficiency. It is suitable for those who want to combine the potential for capital appreciation along with regular income and medium market volatility. Investors should ideally hold equity savings funds for more than a year as most fund houses charge an exit load of 1% for redemption before a year.
Different from balanced fund
In balanced funds of mutual funds, fund managers invest up to 65% of the money in equity and the rest in debt. However, in equity savings fund, the equity component is lower than that of balanced fund but it has the same tax advantage of balanced funds. Balanced funds are suitable for investors with a moderate risk profile and investment horizon of over three years. Balanced funds are less volatile as they get the upside by increasing allocation to equity when the markets are declining, and reduce the equity exposure when markets are rising. At a time when the stock markets are rising and interest rates remain low, analysts say equity savings funds are ideal for conservative investors looking for reasonable returns with stability. The best way to invest in these schemes is through a systematic investment plan.