Why investments must be for long-term; it is not only just about tax efficiency; 3 power points

Published: December 22, 2017 1:03:45 AM

Investments should be in the growth option rather than in the dividend option. This is not only about tax efficiency but about the principle of building your long-term corpus

investments, why investments is long term, short term investments, financial goals, cash-flow situation, short term investments, dividends, long term savingsInvestments should be for a long horizon, for particular time-defined goals, or for retirement.

Joydeep Sen

Expecting your investments to provide for monthly expenses is inimical, but for retirement. You may be thinking that if your investments cannot provide for your expenses, why invest? Let’s look at the logic of the statement. Ideally, you should start saving and investing when you start earning. Even if you don’t do that, even if you start investing in your 30s or 40s, there is a long horizon ahead. Investments should be for a long horizon, for particular time-defined goals, or for retirement. If your long-term savings and investments have to provide for your sustenance before retirement, then it is not your investible surplus in the first place. The other situation could be, you are living beyond your means, hence you force yourself to draw from your long-term investments. Post retirement, there is no concern if the regular flows from your investments, i.e., interest / dividend, is providing for your monthly expenses. There is no concern even if you are drawing marginally from your principal, as long as the principal sustains till your life expectancy. The purpose of saving / investing during your working life is that in your golden years, you don’t depend on somebody else but your own kitty.

The logic

Since investments are long term, you should not disturb it unless it is absolutely essential. While cash flow emergencies may happen, an estimated amount for such events should be parked in liquid / short term investments. Only if the emergency requirement is beyond the liquid investment, long-term investments should be touched. If it is occurring regularly, you need to give it a serious thought. Either you need to curtail your expenses or revisit your financial goals. If you are doing it yourself, the inputs of a financial planner is required. Taxation-wise also it is more efficient; in debt mutual funds, tax efficiency kicks in the growth option (as against dividend option) over a three-year investment horizon. In equity mutual funds, it requires a one-year horizon in the growth option, but dividends are tax-free anyway. The argument is, if the investments are for long term, you should not prefer the dividend option. However, to tide over a difficult cash-flow situation, it is not advisable to take a loan. Rather, you touch your investments for funding the emergency requirement. The interest out-go on the loan is defined and in this case you are indirectly funding a part of your investment through loans, by not disposing a part of your investments. If your investment is not out-delivering your loan cost in that period, you are worse off.

What to do?
Ultimately you have to set your house in order. While a financial planner can give you professional advice, if you are doing it yourself, you have to question your expenses, your financial goals, and the amount required / expected to be available for the goals. If you have drawn on your long-term investments to tide over a difficult situation, as and when things improve, you should gradually replenish. The function of financial planning is to tide over such situations without having to touch your corpus. For example, if it is a medical emergency or loss of job, it may be covered through insurance. If it is an acquisition of an asset, the corpus is built over a period of time through earmarked investments.

Conclusion

Investments are supposed to be long term. In the context of mutual funds, these should rather be in the growth option than the dividend option, and even as a concept in other investments. This is not only about tax-efficiency but about a principle of building your long-term corpus. As and when you enter the withdrawal phase of your life, in the golden years, dividends and principal withdrawals can sustain you.

The writer is managing partner, Sen and Apte Consulting Services LLP

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