BASICS OF INVESTING
Your returns as an investor depend not only on the
performance delivered by your chosen asset class but also by the taxes and expenses that you incur in the transaction.
Two factors that an investor must consider before redeeming are exit loads and capital gains tax as per Income
Tax Act, 1961.
1. Exit load: Exit Load is an amount charged by
mutual fund schemes on redemption of investments before a specified period. It is charged as a percentage of the Net
Asset Value (NAV) as on the date of redemption. Such exit load could range from 1% to even more.
For example, let’s say a scheme charges an exit load of 1% on redemption of investment within one
year. Suppose the NAV of the scheme is `100 on the date of your redemption, you will get only `99 on
your units after application of exit load, if redeemed within 1 year. Exit Load is imposed in order to
discourage short term investing.
2. Taxation: All market related investment products
are subject to capital gains tax owing to appreciation in their prices at the time of sale/redemption by an investor.
Depending on the holding period, they are classified as long term or short term as depicted below.
Long term capital gains typically enjoy lower tax than short term capital gains.
Short term capital gains Long term capital gains
Period Tax rate Period Tax rate gains
Period Tax rate Period Tax rate
Equity oriented mutual fund Up to 1 year 15% More than 1 year Nil
schemes
Other than equity oriented Up to 3 years Gains added to taxable More than 3 years 20% after
schemes or liquid schemes income and taxed at providing
applicable slab rate Indexation
Note: Surcharge at 12% to be levied in case of individual/
HUF unit holders where their income exceeds Rs 1 crore. Education Cess at 3%
will continue to apply on tax plus surcharge. Illustration valid for domestic
(resident) investor.
CUMULATIVE IMPACT OF EXIT LOAD & CAPITAL GAINS TAX ON
RETURNS
(A) Equity Mutual Fund :
The following illustration shows how investors’ returns are
impacted by exit load and capital gains tax. Let us take the example of Mr
Niveshak who invests Rs.1 lakh in an equity mutual fund scheme. Eleven months
later, let us say the investment value has increased to Rs 115,000. Mr Niveshak
planned redeeming his investments considering the appreciation.
Unfortunately, returns from the Scheme reduced after
calculating the impact post exit load (assuming exit load period of 1 year) and
short term capital gains tax. Mr Niveshak’s investment return of 15% reduced to
11.71% owing to the impact of exit load and taxation. This loss can be
minimised by holding investments for the long term and if such favourable
market conditions persist. Had the investor held on to his investments for more
than a year his returns would have been 15%. (Assuming no change in market
condition).
ILLUSTRATION of Mr Niveshak’s investment gains
Early Exit Long Term Investing
S.N. Category 1 year or Below Above 1 year
A Amount invested ` 1,00,000 ` 1,00,000
B Gross Return 15% 15%
C Amount Before Exit Load ` 1,15,000 ` 1,15,000
D Exit Load Applicable 1% Not Applicable
E Amount Post Exit Load ` 1,13,850 ` 1,15,000
F STCG Rate 15.45% Long Term - Nill
G STCG ` 2,140 Not Applicable
H Net Amount After Tax ` 1,11,710 ` 1,15,000
I Net Investment return 11.71% 15.00%
BASICS OF INVESTING
FORMULAE
: E = C x (100%-D), G = F x (E-A), H = E – G, I = (H-A)/A
Short Term Capital Gains Tax rate is as per tax slab
applicable for the financial year 2016. For illustrative purpose to explain the
impact of exit load and capital gains tax and benefits of investing for
long term. There is no assurance or guarantee of returns on investments in
mutual funds.
Investments in mutual funds are subject to market and
various other risks and it is advisable to consult with financial advisor
before investing. Securities Transaction tax has been ignored for
the purpose of illustration. Illustration valid for domestic (resident)
investor
(B) Non-Equity Mutual Fund (Other than liquid schemes)
Let’s say Mr. Niveshak invests Rs.1 lakh in a debt mutual
fund scheme. One year later, let us say the investment value has increased by 12% CAGR (Compounded annual growth
rate). Mr Niveshak considered redeeming his investments owing to good returns from the Scheme.
Unfortunately, returns from the Scheme reduced from 12% to 7.52% owing to the impact of exit load and taxation. This
loss can be minimised by holding investments for the long term and if such favourable market conditions persist.
Now, if Mr Niveshak had held on to his investments for the
long term (more than 3 years), he would not have incurred exit load (assuming exit load period of 15 month)
and he would have paid lower capital gains tax post indexation. In addition, long term investing could be beneficial
with an opportunity for increase in scheme NAV. Assuming investments held for just above 3 years and a CAGR
of 12%, his Net investment return would be 11.46%.
ILLUSTRATION of Mr Niveshak’s investment gains
Early Exit Long Term Investing
S.N. Category (say after 12 months) (Say above 3 years)
A Amount Invested 1,00,000 1,00,000
B Gross return 12.00% 40.49%
(CAGR 12%)
C Amount Before Exit Load 1,12,000 1,40,492
D Exit Load Applicable 1% Not Applicable
E Amount Post Exit Load 1,10,880 1,40,492
F Tax Rate on Gains 30.90% 20% with Indexation*
G Tax Applicable 3,362 2,009
H Net Amount After Tax 1,07,518 1,38,483
I Net Return (CAGR) 7.52% 11.46%
FORMULAE
: E = C x (100%-D), G = F x (E-A), H = E – G, I = (H-A)/A
* Assuming investment in FY 11-12 and Redemption in FY 14-15
Cost Inflation Index = 785 for FY 11-12 and 1024 for FY
14-15
Indexed Cost of Capital = (1024/785)*100000 = Rs 130446
Tax on Gains = (140492-130446)*20% = Rs 2009
^Short Term Capital Gains Tax rate is as per tax slab
applicable for the financial year 2016. This is assuming the investor falls in the highest tax slab. For illustrative purpose to
explain the impact of exit load and capital gains tax and benefits of investing for long term. There is no assurance or guarantee
of returns on investments in mutual funds.
Investments in mutual funds are subject to market and various other risks
and it is advisable to consult with financial advisor before investing. Illustration valid for domestic (resident)
investor.
INVESTING FOR THE LONG TERM IS BENEFICIAL
Happy Investing
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