Freefincal Q & A: Reducing tax outgo from mutual funds

Each week I try to answer generic questions on personal finance from readers. In this weeks edition, I discuss reducing tax outgo from mutual funds, cost of fee-only planning and mutual fund portfolio reviewing. You can use the form below to enter your question. Announcement: Gamechanger paperback is still available at a 25% discount for Rs. 149 only! Grab it or gift it to a young earner

S Kumaresan Thanks for the retirement planner sheet. I wish I had known this when I was in forties! It would be better and more illuminating if the retirement planner is split into to separate computations: (1) Under the stated assumptions, how much corpus one should have at the time of retirement (2) How much to invest to raise the corpus arrived at by (1).

Pattu: Thank you. Try the robo advisory template. That is more comprehensive and in line with your suggestion.

 Manoj: Dear sir, my question is about LIC maturity and tax after reading the 10D(D)etc.still i felt some thing not fitting in any logic. i am salaried and in 30 % bracket.I am having a LIC policy Jeevan Anand (6 yrs quarterly premium ,table 149) from OCT-2011 which matures this was told by the LIC official that sum assured(200,000)+ bonus(~45000) will be credited to me with TDS of 1%. My yearly premium was (10665*4). On reading many articles it seems that whole amount is taxable if it is not under 10D(D),which makes me annoyed becoz , 1) premium paid is 10,000 higher than the total amount i am getting in maturity and have to pay the tax for whole amt. 2) all the money paid are sourced from by salary income for which tax is paid promptly. kindly help by your valuable reply whether it is taxable as it is inferred by me or how to get exemption . i apologise for any inconvenience if question not relevant to our freefincal .thank you

pattu:  The rule is annual premium divided by 20% should be less than or equal to sum insured for entire proceeds to be tax free. Else, yes, the entire proceeds should be added to income and will be taxed as per slab. However, the premium is just the bare premium, excluding service tax and cess. Is this so, in your case?

asheesh:  Dear Sir, I am in MFs couple of years now, and trying to build corpus, but some how I do not have any track on how much is net return on my investment till date. Problem is, say for example, I invested 1 lac. via sip in one fund and lump-sum 2 lac. in another fund after 2 years corpus becomes say 3.5 lac, then I closed both and moved to 3 different MFs with some periodic investment 3.25 lac only 25k i enjoyed .. and so on, if I am realizing gain from one fund keep it for some time and putting back in another fund, so I am not sure now how much I really invested my money out of pocket, and what is actual return. Currently, I am tracking via value research and I have current face value of investments but its realized gain and unrealized gain doesn’t seams me correct. In past I did SIP then .. direct.. and now moved to MFU direct without SIP. another example, I pulled out recently big chunk from small caps and put it back in liquid fund awaiting for Diwali to over, both side I get some return, but how to calculate it in absolute terms I don’t know.

Pattu: That will depend on your definition of what an absolute return is. IF it is annualized return on your corpus from the time you started investing, then you can use my portfolio tracker. This will provide you much better insights and is the only tracker that I use.

Tarun: Is the 8% taxable bond a good option to invest surplus funds of a retiree?

Pattu: I assume you are referring to the 6-year RBI bond available only in the primary market (cannot be traded mid-way). The answer depends on your corpus. How much can you lock up this way. Even if you do, when you redeem and wish to reinvest the rates may be lower – reinvestment risk.

For a retiree who has money to spare (after accounting for expenses in the near future at least), the mantra should be to pay tax only when you redeem. This means reduce interest income and work with capital gains.  Even for this in the 10% slab, partial withdrawals from debt funds can turn a better deal than pay tax on entire interest amount.

The key idea is mentioned here: Do you know what happens when money is redeemed from a mutual fund?

Making partial withdrawals as and when necessary is a smart way to reduce tax outgo from mutual funds in general (eg. short term flexible goals) and post-retirement in particular. This is because, in the case of capital gains, there is no clear demarcation between principal and interest. One of the greatest benefits of freefincal is that I come into contact with intelligent investors, especially early retirees who have perfected the art of reducing tax outgo with debt mutual funds and yet retain full liquidity on the corpus.

This idea is applicable to short-term capital gains tax from equity funds (sooner than later their LTCG will also become taxable). It is such a pity that in spite of being a mutual fund (the largest, in fact), the NPS is not treated as one from a tax point of view! Read more: A Guide to investing in the National Pension System (NPS)

Those who understand this key concept and can select funds carefully, manage to pay considerably lower tax. More on this in the coming weeks.

cake slice - Freefincal Q & A: Reducing tax outgo from mutual funds
Some imagery to go along with the idea of slicing redemptions. Photo by Bob Peters

Rakesh: Hi Sir, I have been investing in HDFC balanced fund for a couple of months (10K per month) as part of my equity portfolio for my retirement (20 yrs from now). Do you think I should continue investing? Or Should I wait until we receive an update from AMC on next steps? Thank you in advance for your suggestion.

Pattu: Continue investing. You can always alter your investments later on if there is merger or change in investment strategy.

Vishal Vashisht: Why stay away from equity small cap if I have holding capacity of more than 10 years. In response to PlumbLine October 2017: a handpicked list of mutual funds

Pattu: “stay away from equity small cap” is what I would do for the simple reason I prefer reasonable returns at reasonable risk and do not fancy potential high reward with guaranteed high volatility.

GK Swamy: Dear Pattu I have just retired, got a portfolio with asset allocation of 60:40 debt:equity, consisting of two equity and two debt funds. I also have three to four years of annual expenses in cash. My question is should I include this cash in the above portfolio in UST debt or create a separate liquid fund for that purpose exclusive of my portfolio.

Pattu: Set up an emergency fund with copious amounts of cash and do not include it in your asset allocation. The debt in your asset allocation should also include some cash in a liquid fund. UST investment is not exactly ‘cash’ but can be treated as such.

Kiran: How does a lump sum investment of 25 lakh INR in a Portfolio Management Services compare versus 25 lakh INR investment through STP and SIP sequentially over a period of 5-10 years?

Pattu: PMS data is sketchy and such a comparison can only be made by a PMS investor.

Samir: Hi, I have been a regular at your blog and infact learnt of Asan Ideas through your blog. I know you advocate a DIY system along with a fee only planner. I was looking through your blog on the difference in costs between a regular and direct mutual fund and found that it is about 1-2% in return. This would mean I would need to look at gains of 25 lakhs ( assuming my fee only planner charges 25000) to actually profit from doing it through a fee only planner as the commission through a agent would then be negated. I noticed that you mentioned above that look for someone who let’s you do your insurance through the company website. Well recently did my term insurance from ICICI found that a agency was able to offer me a much better price compared to the ICICI website price. So is it always beneficial to do it through the company? Or did I just get lucky. Cutting the long story short. Will I really be saving any money through a fee only planner. P.S. – I used to do my mutual funds through IIFL and they sell all mutual funds on one platform. So I don’t believe they are biased towards a particular fund. Thanking you, Best Regards Samir Mervyn Razvi

Pattu:  A fee-only planner for that 25K you mentioned does a lot more than just suggest mutual funds! Investing is only one segment of financial planning. And there are planners who get a similar fee for a financial plan AND get commissions.  Comparing a regular plan portal offering “free” advice on investments alone and a fee only financial planner is an apple to orange comparison.

I am not advocating “direct” for cost saving alone. Offering all funds in the same portfolio does not mean biases do not exist!  A distributor earns more money the more assets you have in equity. So they have a conflict of interest in asking you to rebalance and actively reduce risk in the portfolio.

Ram: Hi, I invest in a GoldETF every month (approx. 5k). This is a portfolio diversification and a hedge against an end-of-the-world scenario. I have read a lot of posts recommending for or against investing in Gold via ETFs. My questions: 1. Is there a ‘transmission risk’ associated with Gold ETFs? That is, are there situations where the price of gold may rise/fall with no comparable rise/fall in the GoldETF price? 2. I have read that liquidating gold ETFs might be a problem especially if the volumes of the ETF are low. How do I figure out if a security (say an ETF) is ‘liquid’ enough based on trading volumes? Thanks, Sriram.

Pattu: If you want to prepare for an end of the world scenario, buy gold and store is safe. ETF is not the solution! If s**t hits the fan, ETFs could suffer. As for diversification, if you invest 5K, the effective diversification implies you are not investing much elsewhere! If you invest a lot more elsewhere then this 5K will not help you much.

Read more: When to invest in gold and when to buy it

Charts: Equity vs. Gold. Vs. Debt

Sanjay: Thank you for your articles and enthusiasm for sharing your wisdom. Could you write some detailed articles on following risk scenarios i.e. use cases. Preferable one article per use case. Use Cases – 1) BJP losing 2019 general election and hung assembly. 2) War Breakout – India involved 3) War Breakout – North Korea/Japan – Super Powers involved – Not India 4) Bubble Burst/Another Great Depression 5) Hyper Inflation Period Take following investor class – mid 30s, mid 40s and mid 50s 1) What the above scenarios means to investor, 2) What is likely to happen to his investment. 3) What are the opportunities available at that time and 4) What should he do during these times. 5) How to preserve wealth at these times 6) How to grow wealth at these times Thank you Sanjay

Pattu: I don’t want to write speculative articles, but will say this much. Out of the 5 scenarios posted, elections pose guaranteed turbulence. As on date, I don’t think BJP will get as many seats as it did last time. As on date, there is no clear alternative also (merely my opinion, with profound apologies to other party bhakts). So the build-up to the 2019 elections will be more turbulent than the last time. So it would be prudent for investors to pull out of equity if their goal is quite close to that time period. All investors should do keep a close watch on their asset allocation and rebalance around that period – either tactically or as per their goal planning.

For the other scenarios, we can only pray. If war breaks out, I think matters other than investing take precedence.

p srinivas: dear pattu sir thank you for the fantastic posts. each day i eagerly check for the updates. I have got some “regular” MF units accumulated in some of the funds over the years. should i switch them to DIRECT now? will there be any difference. i am under the opinion that once bought, the recurring charges, if any, are the same for both direct and regular MFs. can you kindly clarify? p. srinivas

Pattu: Thank you. NO! You are wrong. An agent continues to get commissions from the regular fund for as long as you hold it. Exit now!

Chandra Singh: Hi Pattu, Thank you for all the useful insights. What will be the impact of SIP (Selective Investment Program), investing only when the market is pessimistic (say PE below 18) and shift to debt the moment it rises again above 18? Will it give better returns compared to systematic investment?

Pattu: It is practically guaranteed to lower risk compared to systematic investment. whether it will produce higher returns or not depends on the future market course. See: Is it possible to time the market?

HORY SANKAR MUKERJEE: Dear Prof, This is my second question. Thank you for responding to my first one. This is regarding evaluating the performance of a MF. Although you had written a post earlier on this, i had some more queries. 1. If i had to ask you, what is the simplest, one-two sentence answer to evaluate the performance of a fund, (or a response to beginners) what would it be? 2. The XIRR of my fund is around 13% and i am very happy with it (I do not expect more than 10-11%). But recently (last one year) the fund is not doing well in comparison to its benchmark. It is almost in line with the benchmark. Should i keep it for some more time or do away with it. 3. What are the ‘clear cut’ signals to completely junk a MF scheme? 4. I had 3 funds in the balanced category. Thanks to you, i am planning to bring it down to 2. What should be the factor/factors that should guide me to chop one fund down? 5. I have a MF scheme named Franklin Pension. My retirement is pretty far off (22 years) and i invest only Rs 1000 in it. While the exit load of this fund is very high(3% until you reach 58), i am unsure whether i should chop this down. The returns from this is about 9%. Does it make sense to chop this down and look for other options, since i am putting this money which is far off? Thank you Prof. for the work that you do. I am sure it helps people a lot.


1 What is the simplest, one-two sentence answer to evaluate the performance of a fund, (or a response to beginners) what would it be? Invest with a goal and evaluate the performance wrt to the goal. Not wrt star ratings or peer performance.

2 The XIRR of my fund is around 13% and I am very happy with it (I do not expect more than 10-11%). But recently (last one year) the fund is not doing well in comparison to its benchmark. It is almost in line with the benchmark. Should I keep it for some more time or do away with it. 

Stick to it. I recommend offering at least 3 years or an active equity fund manager to perform, preferably 5. This assumes I know when to invest in such a fund for what goal in the first place!

3 What are the ‘clear cut‘ signals to completely junk an MF scheme?

When the investment mandate changes so much (officially or unofficially) that it is not acceptable to the risk profile of the goal (not your risk appetite).

When the fund does not reduce risk as much as your expectations.

When the fund does not produce returns (absolute or per unit risk taken) even after 3-5Y.

If I know how to select well, I can junk well

Vasuki Rao: I have become a regular reader of your columns and find them very informative. Do you use a portfolio manager to keep track of your MF investments? If yes, which one? Frankly, I’m looking for a free service. Your suggestions would be welcome. Thanks.

Pattu:  I use an Excel sheet that I made: Features of the freefincal mutual fund and financial goal tracker. To this, I have inserted the Excel PPF Calculator and Tracker and The even lower stress retirement calculator!. So each time I update holdings, I also update my financial audit

Rohit: Dear Pattu Sir, Thanks for keenly answering every question as it gives a lot of insights, as a part of investment plan I created buffer 6 times my salary, I want to put this somewhere, currently all that money is lying in bank, is arbitrage fund a good choice for the same, I want to have this fund as a rainy day fund, it should be tax free, low to medium return , not volatile and very liquid.

Pattu: Some in the bank (SB +/-FD) or flexi deposit acct), some in arbitrage fund plus a food credit card

Vikas: Dear Sir, NRI’s get Zero-Tax FD from Banks at the same interest rates like Resident Indians. Most advisers compare 3 Years Debt FMPs with Bank FDs from a Tax saving point of view (with Indexation benefit) for Residents. Sir, What is your opinion about what should an NRI do if he/she wants to include Debt portion to his/her portfolio? Bank FDs / Debt Funds / Balanced Funds?

Pattu:  NRIs should consider the net tax to be paid (in India + country of residence) and also the kind of rates they get in that country. If the tax free FD is favourable on both counts, they can use that for the debt part of the folio. If they want liquidity, they can use debt mutual funds. But from liquidity where is important – In India or abroad. Most advisers get commissions. Enough said.

Have a great week ahead.

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