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It is an old saying that every cloud has a silver lining. The meltdown in India’s markets on account of the covid-19outbreak has cut into the value of people’s mutual fundinvestments. However, on the positive side, this may have also lowered or even completely wiped out any taxable gains, allowing investors to make changes to their mutual fund portfolios without incurring income tax liability while doing so.
According to experts, there are four such changes you can make in your portfolios in order to optimize your gains from any future recovery in the markets.
A sharp fall in the equity market would have shifted your asset allocation in favour of funds that invest in other assets like debt or gold. If you think you should carry on with the earlier asset allocation, you can now move some money from debt and gold funds into equity funds to take advantage of more favourable valuations. For instance, if a 50:50 equity-debt portfolio has become 40:60 in favour of debt, you can move it back to 50:50 by redeeming your debt funds and buying equity funds.
Investors have a tendency to hang on to duds. Some of this stems from an inability to admit and accept mistakes in selecting funds in the past. Continuing with an underperforming fund will mean that your money is not working as hard as it could for you. The present volatility owing to the pandemic gives you a great opportunity to start over with a clean slate.
Note, however, that although the correction may have wiped out the tax liability which you may have incurred when switching funds, you may still need to pay an exit load, wherever applicable.
Typically, exit load is imposed in equity funds for up to one year after the purchase. You can also use the correction to switch from dividend to growth plans of mutual funds. Budget 2020 abolished the dividend distribution tax (DDT) on stocks and mutual funds and made dividends taxable at slab rate in the investors’ hands. This significantly increases the burden for investors in the 30% tax bracket. Earlier, dividends were tax-free in the hands of investors although DDT was imposed on equity funds at 11.65% and debt funds at 29.12% (including surcharge and cess).
Many investors buy mutual funds as if they are stocks and end up with vast portfolios of 20-30 schemes. Since a mutual fund typically holds 30-50 stocks, a portfolio of more than six to eight equity funds will tend to just replicate the market on average and cancel out any outperformance or alpha. It will give returns similar to an index fund without the low costs of an index fund. Since index funds mimic the index they track, there is only a small fund management fee you have to pay. “Investors should consolidate their portfolios. Get down to four to eight funds, ideally index funds," said Gaurav Rastogi, CEO, Kuvera, an online mutual fund investment platform. This will also help you track your funds better and rebalance your portfolio on a regular basis.
If you are a do-it-yourself (DIY) investor and are confident of your ability to plan finances, you can take this opportunity to shift out of any legacy regular plans you may have and move into direct plans. In doing so, you can rebalance your mutual fund portfolio, if required.
If you are not a DIY investor and you do need advice, you can shift from a distributor charging commissions to a Sebi-registered investment adviser (RIA) who charges a fee. Typically, fees tend to be negotiated at lower levels compared to distributor commissions, particularly for investors with large portfolios.
However, some experts have noted that investors may not see the cost saving potential of a switch. “Psychologically, I don’t think clients will shift from distributors to RIAs. People see fees as more expensive than commissions and I don’t think they’ll want to shift at a time when their portfolios and, possibly, incomes have been hit," said Nishith Baldevdas, a Chennai-based Sebi RIA.
Conducting any or all of these four shifts can potentially reduce costs and improve the returns of your mutual funds portfolio. Proceed cautiously and only make the changes that are right for you, given your goals, risk appetite and ability to manage your own mutual fund investments.
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