Fixed Income Investing – Have the cake and eat it too!!

Fixed Income Investing – [ Have the cake and eat it too!! ]


In this part, I want to highlight one of the best benefits of investing in mutual funds in India for fixed income part. It is called indexation benefit. Let me explain this with real life example.

We will assume Mr.Suresh and Mr.Ramesh both invested Rs.1 Lakh in fixed income instruments on 23-Mar-2007. Mr.Suresh opted for Debt mutual fund and Mr.Ramesh opted for Bank FD.

  1. Mr.Suresh bought HDFC Floating Rate fund (Growth) scheme on 23-Mar-2007 for Rs.100,000. [ NAV=12.5772, Units=7950.895]

Today on 18-Dec-2011, the scheme NAV =17.5638, value of the investment = 139,648.
Growth of the investment is 39,648, or absolute 39.6%.

  1. Mr.Ramesh had chosen fixed deposit. We assumed Mr.Ramesh also received same return on his investment, since the purpose of this exercise to compare the post-tax returns. Being in top tax bracket, he would have paid 30.9% of the 39,648 as tax to the Government. That is a tax of Rs.12,251. His investment would be only worth of Rs.1,27,397 today, after taxes.

Let us see now see the tax implication of choosing the mutual fund route.
First thing, we should note is that both of them have not liquidated their investment and the money is continue to be invested for future need. Mr.Ramesh has paid a tax of Rs.12,251 so far and will pay some more for this year’s growth. Mr.Suresh has not paid even Rs.1 as tax so far for this investment since he has chosen the growth scheme. [Suresh leads 1-0]

Next we will compare the tax impact, if both of them have to liquidate the investment to meet certain expenses today.

If Mr.Suresh sells this investment today, he has a choice either to opt for (a) 10% tax without indexation or (b) 20% tax with indexation. And he also has the liberty to choose any method he wants.
Using 10% without indexation benefit, his tax bill is 10% of 39,648 = Rs.3,965. This is only 25% of the tax paid by Mr.Ramesh, a very big savings for Mr.Suresh.
[Suresh leads 2-0]

Now let us also compute the tax using the indexation benefit. His tax calculation will be as follows:
Indexation cost of investment = (785/519)*(100,000) = 151,252
From sale proceeds, subtract the indexed cost = 139,648-151,242 = (-11,604)

We have a loss.

By opting for indexation method, Mr.Suresh need not pay any tax for this gain. [Suresh leads 3-0] Interestingly, he is also allowed to adjust this loss of Rs.11,604 against any other capital gains, thus reducing his tax bill even further. If he is not able to adjust all of his losses in current year, he can carry forward this loss to next year. [Suresh leads 4-0]

In addition to this preferred tax benefit, Mr.Suresh enjoys full liquidity, and can liquidate his investments any time to meet any unexpected expenses anytime. He can also withdraw money in several installments over a period of time. [Suresh leads 5-0]

This is what I call – Have the cake and eat it too !!

Last year, one of my clients adjusted his capital gains from a Real Estate deal using gains from debt funds for about Rs.3 Lakhs and neutralized all the taxes.

Anyone can adjust the capital gains with capital losses. Adjusting gains with gains? This is one of the secrets of good tax planner. Now you know that !

Bring your fixed income portfolio to debt mutual funds and save on taxes.
If you need help in fund selection, don’t hesitate to contact me.


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2 Responses

  1. Mathi says:

    Is there any Mutual Fund Scheme available with Life Insurance of the Investor?
    Kindly inform me in details. Thanks.

  2. RRK says:

    Why do you want to buy mutual funds along with insurance ?
    You can buy them separately.

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