Equity funds have found their place in the sun in the present stock market boom. Fund houses kept launching equity funds and everyone flocked to them.
Which brings us to balanced funds. Are they worthwhile investments?
Let's understand them first.
By definition, they are funds that invest in both equity (shares) and debt (fixed return investments). Initially, balanced funds used to invest at least 50% of total investments in equity. By doing this, they were classified as equity funds for tax purposes.
This Budget, the finance minister has said that funds with at least 65% (not 50%) in equity would be defined as equity funds. So, balanced funds would have to invest at least that much to avail of the tax benefit.
Understanding the tax impact
Debt funds
If you sell your mutual fund units within a year, you pay short-term capital gains tax. The amount is added to your overall income and you get taxed depending on the tax slab you fall under (10%, 20% or 30%).
If you sell your units after a year, you pay long-term capital gains tax. This is 10% without indexation or 20% with indexation, whichever is lower. Indexation is the process by which inflation is taken into account when calculating the profit.
Equity funds
If you sell your units within a year, you pay short-term capital gains tax of 10%.
If you sell your units after a year, you pay no long-term capital gains tax.
How does that affect you?
Fund managers who want their investors to avail of the preferable tax benefit given to equity fund investors will have to ensure at least 65% of their fund's total investments are in equity.
If it falls below this amount, it will be classified as a debt fund and they will not get the tax benefit reserved for equity funds.
So, if you don't want a fund that is heavily invested in equity, you will have to look for a balanced fund that has invested less than 65% in equity.
Moreover, equity funds do not have to pay dividend distribution tax. Debt funds have to pay 14.025% tax, including education cess and surcharge.
If the balanced fund has less than 65% in equity, it would have to pay the tax. This tax is paid out of the investors' money before the dividends are distributed.
Who is it for?
Balanced funds could serve an investor in a variety of ways.
Balanced funds are great for those who want to invest in equity but don't really have the stomach for it.
An investor who is just starting out in equity investing but is wary of the risk, can opt for these funds. It is a great way to kickstart equity investing.
Or, it could be targeted at an investor who has a fair amount in equity and just wants to balance his overall investments with some debt.
Alternatively, it could also be targeted at those who are starting off with investing. By investing in a balanced fund, the investments are automatically balanced between equity and debt.
These funds tend to be safer than equity funds because of their debt allocation. At the same time, they generate returns good enough to keep you engaged.
Would you like to invest in one?
As on February 28, 2006, the balanced funds together had Rs 4,312 crore under management.
This is certainly not much. However, as long as equities continue to generate breathtaking returns and the Sensex keeps scaling new heights, we won't see much action here. Investors will opt for equity funds.
Do note: If you already have a bulk of your investments in equity, you could try investing in debt to balance it or consider a balanced fund.
The real worth of a balanced fund is during tough times. When the market falls taking the equity funds along with it, a balanced fund may be keep your investments safe. We are not saying balanced funds will guard your assets completely. But they will definitely not sink as much as their equity counterparts.
If you choose your fund carefully, the rewards could be handsome. While there are many options, HDFC Prudence stands out in the crowd. Such has been the performance of this fund that we don't have any hesitation in saying it should your default choice.
Tomorrow, we give you the names of the best players.
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