In the current financial climate where debt funds, international funds, and gold funds have lost their indexation benefits, many conservative investors have found themselves in a conundrum. Indexation benefits, as we know, serve as an inflation-adjusting feature that can considerably lower tax liability. As these benefits decrease, there is a critical need to identify other mutual funds that still offer this crucial advantage.
What are Indexation Benefits in India?
In India, indexation benefits are a tax-adjusting feature provided to investors, primarily to protect them from the impact of inflation. By adjusting the purchase price of an investment to reflect inflation, indexation benefits can significantly reduce the taxable amount of capital gains. Essentially, it aids in lowering the tax liability, thus enhancing the overall returns from the investment.
Current State on Indexation Benefit in India
The 2023 Finance Bill amendment in India has unexpectedly eliminated indexation benefits for debt mutual fund gains, meaning they will now be taxed according to the investor’s income slab rates. This change has left many investors and financial experts surprised and concerned.
The move is expected to negatively impact the mutual fund industry, corporate bond market, and investors who now face higher tax liabilities. Furthermore, the government’s own initiatives like the 2019 Bharat Bond Fund, designed to fund public projects through bond investments, may also suffer due to this amendment.
However, not indexation benefit is still not gone by 100%. Keep reading to learn more.
Hybrid and Multi-Asset Funds: A Ray of Hope
Currently, there are a few types of mutual funds that still retain the coveted indexation benefits. These include balanced hybrid funds, multi-asset funds, and dynamic asset allocation funds. However, it’s important to understand that the indexation benefits are largely contingent on the equity allocation of these funds.
Balanced hybrid funds, with an equity allocation that typically ranges from 40% to 60%, previously activated indexation benefits. Unfortunately, no balanced hybrid funds are currently available in the market. There are, however, a few solution-oriented funds that offer similar benefits, such as UTI’s children’s career savings funds and retirement benefit pension funds.
Multi-asset funds, on the other hand, invest in at least three asset classes, including equities, debt, real estate, international securities, and commodities like gold and silver. However, the equity allocation can vary widely, and indexation benefits apply only if the equity allocation lies between the 35-65% range. While these funds do offer the possibility of indexation benefits, their investment in commodities and real estate may not be ideal for long-term investments.
The DIY Approach: Worth Considering?
Dynamic asset allocation funds, also known as balanced advantage funds, can technically choose to have a 35 to 65% allocation in equities and the remaining in debt. However, many of these funds have a higher equity allocation, which might not align with the investment strategies of conservative investors and retirees.
In light of this, it seems prudent to consider whether a do-it-yourself (DIY) approach to a 40-60 equity-debt allocation might be more beneficial. We have found that although the DIY option might have a slightly higher tax liability, its post-tax returns are considerably higher, particularly if the equity component is invested in a flexi-cap fund and the debt portion in a short-duration debt fund.
Final Thoughts
In conclusion, it appears that a DIY approach to asset allocation may make more sense for conservative investors or retirees looking for a 40% exposure to equities, despite the slightly increased tax liability. It is, however, essential to enter the DIY investment realm with a sound understanding of the financial market. Potential investors should only opt for the DIY option if they have the knowledge and time to monitor and adjust their portfolio accordingly. As always, individual investment decisions should align with personal financial goals, risk tolerance, and time horizon.
What did we learn?
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