One of the most effective wealth building mechanisms is that of the mutual fund. Note that we call it a mechanism and not an investment instrument – why is that? Well, while most investors tend to perceive a mutual fund as another instrument that
one could invest money in, in factuality it is not.
Rather, a mutual fund is a vehicle for the funds to reach the eventual desired destination. Say you wish to invest in bonds – you can do it through a mutual fund. Or is it government securities that you would rather invest in? Well, again, you can do so by investing in a gilt fund. If gold is where you would rather put your money, you may do so by way of a gold fund. The same goes for equity shares. And then there are combinations. If you would rather that a bulk of your money be invested in bonds with a sprinkling in equity, then an MIP fund is the answer for you. On the other hand, if the debt equity mix needs to be tilted towards equity, one should opt for a balanced fund. So you see, a mutual fund, in effect, is not the end but rather a means for the end.
Now, as mentioned above, mutual funds come in various flavours – open- ended, close ended, sectoral funds, balanced funds, monthly income plans, fixed maturity schemes, gilt funds, income funds and so on. However, the Income Tax Act only recognises two types of funds: Equity Funds and Non- Equity Funds. Period.
Tax benefits differ for each one.
An equity fund, to put it simply, means a fund that invests more than 65% of the money in equity shares.
The Income Tax Act has bestowed enormous tax benefits on such funds. Lets see what these are: For an equity fund: œ Long- term capital gains are tax- free œ Short- term capital gains are taxed at only 15% œ Dividend is not subject to dividend distribution tax.
On the other hand for a non- equity fund: œ Long- term capital gains are taxed @ 20% with indexation or 10% without indexation œ Short- term capital gains are to be added to the other income of the investor and taxed at applicable slab rates œ Dividend is subject to a 12.5% distribution tax.
œ There is no STT applicable Budget 2006 does away with the differentiation between Open- Ended and Close- Ended Funds Close- ended funds are those that have a fixed maturity date. Open- ended funds are on tap – there is no maturity date as such.
Prior to Budget 2006, only open- ended equity funds had freedom from dividend distribution tax. Close- ended funds, even if investing 100% in equity had to bear this tax. This anomaly has since been rectified.
Another variant of an Equity Fund Then there are ELSS funds ( Equity Linked Savings Schemes). ELSS, to put it simply are equity funds that offer a tax benefit over and above those mentioned above. Any investment in an ELSS fund offers Sec.
80C deduction i. e the amount invested is deductible from your taxable income. However, Sec. 80C has a cap of Rs. 1 lakh……. so only an investment up to Rs. 1 lakh gets the tax benefit.
The following table illustrates the same with a simple example: Now, tax saving presupposes a lock- in. In other words, without a lock- in period, Sec. 80C benefit is just not available. All instruments under Sec. 80C have a lock- in and so does ELSS. But at just 3 years, it is one of the instruments where money is blocked for the least amount of time.
Also, ELSS funds in general have been found to outperform their equity diversified counterparts. This happens essentially as the fund manager has the money at his disposal over the long- term without having to cater to everyday redemptions.
Therefore, regardless of the tax benefit, even investing over Rs. 1 lakh may be an idea to consider.
Which to choose? Here we donalt39t mean investment options but options within the investment.
As most investors would know, mutual funds come with essentially three options œ Dividend œ Dividend Reinvestment & œ Growth The dividend option is pretty straightforward, in that, as dividend is tax- free, those investors who pr
