COVER STORY

Dealing with a double whammy

To meet your financial goals, you will have to invest more across assets

18-dealing-with-a-double-whammy

Equity-related investments, other than unit linked insurance plans (ULIPs), are subject to long-term capital gains tax. Invest today to enjoy tax-free long-term gains along with a life cover.” This is a new SMS from an insurance company that has been doing the rounds since the Union budget was presented in Parliament.

The last full budget by Finance Minister Arun Jaitley has thrown a spanner in the works as far as investments are concerned, particularly in the case of equity investors.
Over 2017, equity markets surged, with the benchmark indices rising over 28 per cent. However, since the Sensex peaked at 36,443.98 points on January 29, there has been a correction of around 6 per cent.
With the proposal to levy a 10 per cent tax on dividend income of mutual funds, systematic withdrawal plan could be a more viable option for those seeking a regular monthly income from their investments.
Senior citizens, who typically look for risk-free investments, have an option of investing in Senior Citizen's Savings Scheme, where they earn an interest of 8.3 per cent.
With prices bottoming out and developers giving attractive offers, this could probably be a good time for prospective home buyers to take the plunge.

The last full budget by Finance Minister Arun Jaitley has thrown a spanner in the works as far as investments are concerned, particularly in the case of equity investors. In the budget for 2018-19, a 10 per cent tax on long-term capital gains (LTCG) exceeding Rs 1 lakh per year has been proposed. Furthermore, to bring in a level playing field, it has also been proposed to levy a 10 per cent tax on dividends distributed by equity mutual funds.

Over the last 18 to 24 months, equity investments, particularly, via mutual funds, had picked up significantly. As equity markets soared to new highs, more people got attracted to it, even as other traditionally popular investment avenues like real estate and gold became less attractive. Particularly, on the realty side, the residential market slowed, prices either remained stagnant or, in some markets, fell, more so, after the government's ban on high-value currency notes.

According to data from the Association of Mutual Funds of India, between April and December 2017, equity mutual funds saw inflows of Rs 1,48,000 crore. A further Rs 77,977 crore was invested in balanced funds—in which part of the funds also go into debt instruments, apart from equity.

Although equity markets can be volatile, over time they tend to offer returns that are much higher than other options like fixed deposits, fixed income funds and small savings instruments. The other attraction of debt funds was that there were no capital gains tax, if one held the investment in a stock or an equity mutual fund for more than a year.

“The introduction of LTCG by the 2018 budget shall make investments in equities and mutual funds a less attractive proposition and would have a negative impact overall on the business cycle as people would look for traditional avenues for investments,” said Suresh Surana, founder, RSM Astute Consulting Group. Although Jaitley made sure that gains made up to January 31, 2018 would not be taxed, it still makes future equity investments less attractive, said Surana.

“The difference between short-term capital gains tax that is 15 per cent (plus applicable surcharge and cess) and LTCG on equities and mutual funds traded through stock exchange is now only 5 per cent,” he said.

Should long-term equity mutual fund investors then look at ULIPs as an option, considering that here, too, a major portion of the premium one pays is invested in equity and debt funds and there is no LTCG?

ULIPs offer insurance protection and the corpus that is invested in equity and debt funds can also help generate long-term capital if a person continues to pay the premiums for the entire period of the policy.

However, a key point to note is that if a fund underperforms, in case of mutual funds an investor can withdraw the money invested and switch to another fund or even another fund house. But in case of ULIPs, an investor can only choose between funds and has no option to change the company. There is also a five-year lock-in period once you have bought a ULIP. Equity-linked mutual fund savings schemes (ELSS) only have a three-year lock-in period.

The costs (expense ratio) that one bears on the money invested also tend to be lower in case of mutual funds over ULIPs. Also, experts point out that though ULIPs may look more attractive over equity funds right now, it may not be necessarily so in the future.

“The returns from ULIPs need not always be tax-free,” said Navin Chandani, chief business development officer at BankBazaar.com. “The amount you receive on maturity is exempt from tax only if the premium you paid on the policy during the term is less than 10 per cent of the sum assured. If the premium amounts are over this percentage, the entire money received at maturity is added under income from other sources in the income tax return and taxed at the slab rate applicable.”

Over 2017, equity markets surged, with the benchmark indices rising over 28 per cent. However, since the Sensex peaked at 36,443.98 points on January 29, there has been a correction of around 6 per cent, which could also put investors in a fix about whether to stay invested in stocks or book profits and switch to fixed deposits or other savings instruments before markets fall further.

With the interest rates likely to rise in the coming quarters, some analysts said there could be some money shifting from equity to debt. “Should the market remain volatile, I do see a tilt happening to fixed income this year,” said Jaideep Hansraj, CEO, wealth management, Kotak Mahindra Bank. “There is a possibility that more new money might go to debt versus equity this year if interest rates go up.” However, its always difficult to time the market, said analysts. Therefore, Hansraj said he is a “strong believer in asset allocation theory” (an investment technique which aims to balance risk and create diversification by dividing assets across a number of major categories).

Also, past experience suggests that equity markets deliver strong returns and help in long-term wealth generation over cycles and, therefore, analysts said that people with long-term goals should stay invested over a long period, and not worry too much about short-term volatility.

“All investments should be made based on your financial goals,” said Amar Pandit, founder of HappynessFactory.in, a financial planning firm. “No one knows where the tipping point in the equity market is. Hence, we don't advise timing the market. One should consider investing in equity as an asset class with a long-term horizon of at least five years.”

Corporate earnings have improved over the last two quarters and with the business cycle on the cusp of recovery, equities should not be ignored, despite the valuations looking stretched, said analysts.

“A lot of these cyclical companies (metals, infra, capital goods) have gone through a fairly long period of consolidation in a tough economic environment,” said Ashish Shanker, head of investment planning, Motilal Oswal Private Wealth Management. “They are just about coming out of that phase. Metal prices have increased in the last one year, cement volumes are showing an uptick and commercial vehicles sales are showing an upward trend. So, the business cycle is just about reviving. Next two to three years, [chances of] 15 to 20 per cent increase in earnings are pretty high.”

Even as experts advocate long-term equity investments, one must remember that most brokerages and investment banks are expecting equity returns in 2018 to be low to moderate compared with the 28 per cent gains in benchmark equity indices last year.

“Markets may continue to be choppy this year, particularly with several state elections around the corner,” said Shanker. “My best estimate is that returns could be a single-digit number.”

While equities are advocated for the long term, liquid funds (short-term debt mutual funds, where investors park money for a few days or months) could be the best bet for the short term, particularly a year or less. Their returns are higher than fixed deposits and the risk factor is less than equity funds. Liquid funds invest in short-term money market instruments such as treasury bills, short-term corporate deposits and commercial papers. This makes them very liquid and safe. Moreover, exit load (a fee charged when an investor leaves a scheme or company) is not applicable.

“You need to have a holistic view of your savings and investments,” said D.P. Singh, executive director, SBI Funds Management. “A large amount of money is still lying in savings bank accounts. Liquid funds over any period, on a tax efficient basis, would have delivered returns better than deposits. While the savings rate is 3.5 per cent, in an ultra-short term fund, you would have earned 7 per cent.”

Many people opted for dividend options in equity mutual funds to receive regular income. However, now with the proposal to levy a 10 per cent tax on dividend income of mutual funds, systematic withdrawal plan (SWP) could be a more viable option for those seeking a regular monthly income from their investments.

An SWP gives people an option to withdraw their invested corpus over a period at regular intervals, rather than having to withdraw the entire amount in one go. A big benefit is that you only withdraw the amount that you need and the rest continues to remain invested, generating returns over time. It is also tax efficient.

“In case of SWP, you pay tax only on the gains portion at the time you withdraw, which is very small in the initial years,” said Singh of SBI Funds. “As the years go by, it will go on increasing but even in the fourth and fifth year, it will be much lower than your marginal rate.”

This February, SBI Mutual Funds launched Bandhan SWP, which provides a tax efficient option to send monthly cash flows from mutual funds investments to immediate family members. UTI Mutual Funds, too, has a similar facility called UTI Family. These products could be particularly useful, in case one is looking to provide money to their dependent parents.

SMALL SAVINGS INSTRUMENTS

For those seeking guaranteed returns at low risk, Public Provident Fund (PPF), National Savings Certificate (NSC) and Kisan Vikas Patra (KVP) have been the go to products. PPF, is particularly helpful for long-term savings, considering that the investment is tax-free and returns, which are guaranteed by the government, are tax-free too. A PPF account has a tenure of 15 years, and can be further extended indefinitely, five years at a time.

As far as NSC is concerned, investments up to Rs 1.5 lakh each year get tax exemption under section 80C of the Income Tax Act, 1961. The interest earned, which is compounded and re-invested by default, is also exempted from tax. However, upon maturity, the interest earned in the final year is taxed.

Sukanya Samriddhi Yojana is a government initiative for the welfare of the girl child. Under this scheme, an account can be opened in any post office or authorised scheduled commercial bank and the interest rate currently offered is 8.1 per cent, which is higher than PPF.

Senior citizens, who typically look for risk-free investments, have an option of investing in Senior Citizen's Savings Scheme, where they earn an interest of 8.3 per cent.

However, it must be noted that interest rates on small savings instruments have been recalibrated quarterly from April 2016 and have been coming down slowly in recent years, in line with the yields on government securities.

The government had reduced interest on some small savings schemes by 0.2 per cent last December. Currently, PPF and NSC fetch an annual interest of 7.6 per cent. Interest rate on PPF has fallen by 1.1 per cent from 2015-16. Interest on KVP has also come down to 7.3 per cent now from 8.7 per cent in 2015-16. Despite the fall in interest rates, experts still bat for such schemes to be a part of one's investment basket.

“Reduction in interest rates may hamper investment in such schemes to some extent,” said Surana of RSM Astute Consulting. “However, the primary motive of investing in such schemes is that interest earned on them is usually tax-free. Hence, even after reduction in interest rates, they still offer attractive after- tax returns compared to other investments. Also, these schemes are less risky and hence provide a fixed source of income.”

Over the past couple of years, interest rates on fixed deposits have also come down from as high as 10 per cent to around 6 per cent. However, there is a feeling that interest rates may have bottomed out. Already lenders like the State Bank of India have hiked rates on bulk deposits and the expectation is that lending as well as deposit rates will start inching up, with bond yields surging. The Reserve Bank of India is also expected to hike interest rates if inflation continues to shoot beyond its targeted range.

However, analysts noted that post tax, fixed deposits will still underperform against other investments and, therefore, is not a great tool for long-term wealth creation. “They are more of a savings product than an investment product as after tax the real return from fixed deposits tend to be lower than inflation at most times,” said Chandani of BankBazaar.com.

REAL ESTATE

Real estate has been another favourite investment destination, particularly among high net worth individuals. However, in recent years as prices in major metro markets stagnated, investor appetite declined. End user demand, too, came down because of high prices. Demonetisation further hit the sector hard. According to data from consultancy Knight Frank, sales volumes in India's major metros were up by only 3 per cent last year. In Mumbai, weighted average prices declined 5 per cent in 2017, the first time prices have fallen in the metro in this decade.

Real estate experts see a pickup in the sector going ahead, as the effects of demonetisation fade, buyers get more confidence due to Real Estate Regulation and Development Act,0 and developers offers various promotions to reduce inventories.

“We are already seeing the green shoots of revival and the emergence of a real estate market whose future growth is based on much firmer fundamentals than ever before,” said Anuj Puri, chairman of Anarock Property Consultants. “The sector's growth from here onward will be sustainable on the back of increased transparency and accountability. Prices have bottomed out and attractive offers far beyond the usual festive season peaks are ongoing.”

With prices bottoming out and developers giving attractive offers, this could probably be a good time for prospective home buyers to take the plunge. Also, to be noted is that home loan interest rates may also not fall further from the current 8.30 to 8.40 per cent. However, the ideal option could be to opt for ready apartments or those that are nearing completion, which will reduce the risk of apartments not being delivered in time.

"There is a very generous swath of options in ready-to-move apartments, with prices for such options which are on par with what they were for under-construction projects a few years ago,” said Puri. “Also, ready-to-occupy flats have the least risk, and what you see is what you get.”

All in all, with long-term equity gains now going to be taxed and interest rates on small savings also falling slightly, people will have to ensure they invest slightly more and across assets to ensure that they meet their future financial goals.

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