Budget 2014: Short-term goal planning is now easy!

Published: July 11, 2014 at 2:34 pm

The tax arbitrage between debt mutual funds and fixed deposits/recurring deposits does not exist for less than 3 years.  This announcement, made by finance minister yesterday, has left many investors and mutual fund distributors worried.

For those who believe that investing has to be done with a future expenditure in mind, this is welcome news. Or at least it ought to be.

Planning short-term goals (less than 3 years away) has now been made easy! I would say even trivial.

Prior to the announcement yesterday, the holding period for long-term capital gains to be applicable was one year.

So people who wanted to plan for short-term goals (above 1 year to few years) were confused about the instrument of choice:

FDs, RDs, liquid fund, ultra-short term fund, banking debt fund, income fund, short-term gilt funds, FMPs (incl. double-indexation) etc.

This confusion split over to even those whose goals were less than 12 months away!

Now the holding period for long-term capital gains has been made 3 years.

Therefore for all durations less than or equal to 36 months, the taxation rule for debt mutual funds is the same as that for  FDs/RDs.

So no more worrying about what to choose!

If your goal is less than 3 years away,

  • choose a fixed deposit if you have a lump sum to invest
  • choose a recurring deposit if you want to invest monthly

As simple as that.

Pondering, ‘what gives the highest post-tax return?’ for 3 years or less is now complete waste of time.

Since the power of compounding is not relevant for short durations, worrying about high returns was always a waste of time!

Remember that debt fund returns (incl FMPs) are not guaranteed.

There is no need to take on that volatility when there is no tax advantage.

Short-term goal planning is now trivial due to lack of choice!

Acche din for financial planning! Not so Acche din for fee-based financial planners and mutual fund distributors?!

What about arbitrage funds? Are they not relatively risk-free and tax-free after one year? Read more about arbitrage funds here

They can definitely be used if the goal is more than a year away. But please note that on a day to day basis, these funds lose money  on a regular basis. The loss will be small.  They have generated negative returns over a month or even over a quarter.

So far they have not lost money over a year. But they could! So tread carefully. Their long-term capital gains maybe taxed in future!

Now let us consider some other implications of the budget.

Dividend Option

How about choosing daily/weekly/monthly divided reinvestment option for short-term goals or for storing some cash intended for equity investment when the market dips?

Unfortunately the effective dividend distribution tax has now increased by at least 2% or so (from what I read; my own calculations point to a much higher increase). According to Deepak Shenoy of Capital Mind, it is about 6% more. That is an effective DDT of 28.2%. I will need to understand this better.

For those in 10% and 20% slabs it makes no sense to choose the dividend option as before.

The advantage for those in 30% slab is still present but has reduced by a huge margin!

Liquid funds funds with periodic dividend payout or reinvestment is still an attractive option for those in the 30% slab, provided they use it for the right purposes.

Retirees/Senior Citizens

Those who are managing retirement expenses with debt funds would feel the pinch, especially if they redeem from a large corpus each month. They will need to wait 3 years for the indexation to kick in.

Now a  significant portion of the corpus will have to be shifted to debt funds 3 years before retirement to optimize monthly withdrawals. This may not always be possible.

Investors who have held a debt fund many years before retirement  may probably adapt to this ruling better.


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