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Short-Term Investing Could Chop Off One Fourth of Your NAV Gains

Equity fund investors are better off staying invested for the long-term to get the best post-tax returns

Equity fund investors are better off staying invested for the long-term to get the best from tax-saving investments.

Some investors like to treat their investments like a game of cards. They make some short-term gains and quickly prepare to walk away with the gains. Rajesh Mahajan (name changed), found himself in a situation like this. He had invested into diversified equity funds three months ago and was surprised to see their NAV appreciate by 15% so quickly. It was sheer luck that his investment timing coincided with a strong rally in the equity market.

But having gained 15%, he was in two minds. Should he book profits now or hold on (to gain more)? One of his friends, with a mathematical bent of mind, figured out for him that he had already made an awesome 75% on an annualized basis. "A good time to book profits," he advised. His other friends confused him but fortunately, he came to us.

So what was our thinking on this question?

First of all, we gave our argument as to why ‘Now’ is still a good time to hold on to equities. While you could read about this in detail here (Equity Mutual Funds – Should You Stay Invested, Or Book Profit?), our short answer was that while the current rise may seem like a blip, a strengthening Indian economy is likely to lead to even higher equity values.

Second and more importantly, we told him to look at his true returns rather than get carried away with high percentage numbers. Mr. Mahajan had invested Rs 1 lakh into equity funds in March’14 and the funds’ NAV has appreciated by 15% since then. If he redeems his funds now, he would make an absolute profit of Rs 15,000 on a pre-tax basis. However, what he would actually get is only Rs 11,495 (almost 25% lower) reducing his 3-month return to 11.5%of investment. How is that possible?

This is thanks to the fact that most equity funds today have exit loads, a kind of penalty levied for selling a fund in less than a year. These loads are usually one per cent of the NAV at the time of sale. In the case of Mr. Mahajan, he would pay Rs 1,150.

In addition, Mr. Mahajan also has to pay tax on his profit. Indian tax rules stipulate higher taxes for short-term profits Vs long-term profits on equity funds. Any long-term investments or capital gains (gains from funds redeemed after a year or so) made would have zero tax liability. However, a short-term capital gain (for funds sold within a year) would attract an effective tax of 17% (16.95% to be exact). Since Mr. Mahajan sold off his units within a year (3 months to be precise), short-term capital gains tax would be applicable, which would chop off Rs 2,355 from his realized gain.

This leaves a profit of Rs 11,495 and not Rs 15,000 on a lakh of investment.

After understanding this, Mr. Mahajan chose to stay invested.

Scripbox investors always know how much of their profit is short term so they can make an intelligent decision. For the annual rebalancing process, our special algorithm ensures tax-free and load free rebalancing of the portfolio. How is that done? We track and make sure that the units being rebalanced are free of exit load and are long-term for tax purposes. This also ensures that you, our investors,make the best possible post-tax return on your hard earned investment.

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