To many investors it would appear that the Union Budget 2004-05 has thrown a spanner in the works as far as mutual funds are concerned.
The long-term capital gains waiver has been extended only to tradeable securities, a category in which mutual funds are yet to gain an entry.
By the same yardstick mutual funds have also lost out on the flat 10 per cent levy on short-term capital gains. A lot of retail investors have taken this as a cue to invest directly in the stock markets as opposed to investing indirectly through mutual funds.
We beg to differ with this line of thinking.
First let's understand the tax benefits extended to tradeable securities a little better in light of the budget speech made by the finance minister. His exact words were: "I propose to abolish the tax on long-term capital gains from securities transactions altogether. Instead, I propose to levy a small tax on transactions in securities on stock exchanges. The rate will be 0.15% of the value of security."
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What comes out very categorically from the above lines is:
a) Abolition of long-term capital gains
b) Levy of 0.15% transaction tax in lieu of the above waiver
In lieu of the above waiver are the operative words in point (b). Stocks and other tradeable securities have been granted the largesse of a long-term capital gains waiver combined with a flat 10% levy on short-term capital gains at a price a 0.15% turnover tax.
The bad news is that mutual funds have not been granted the long-term and short-term capital gains benefit. But the good news is that they have been spared the 0.15% turnover tax.
The last bit hasn't gained currency within the mutual fund community as yet. Fund houses and investors are upset at mutual funds being kept outside the ambit of the capital gains benefit.
What needs to be appreciated is that they have also been kept outside the ambit of the 0.15% turnover tax. You can be sure that since the two (capital gains benefit and 0.15% turnover tax) are linked, if and when mutual funds are extended the capital gains benefit, investors will need to shell out the 0.15% turnover tax.
In times of increasing entry loads, you can be sure the turnover tax will be far from welcome.
We still haven't got down to discussing why retail investors should prefer mutual funds over direct investing in stock markets. But what we wish to highlight strongly over here is that whatever be the reason for investing in mutual funds, it certainly should not be for tax benefits!
Investors would be doing a disservice to mutual funds if they had to bring it down to a level where tax benefits would dictate whether mutual funds should or should not form a part of their portfolio.
At the risk of sounding repetitive we would like to take this opportunity to highlight better the benefits of investing through a mutual fund:
The biggest plus of investing in a mutual fund is the presence of a professional money/fund manager who takes investment decisions on your behalf. This is a big advantage even if it's not totally appreciated by mutual fund investors.
But if you want to be able to appreciate it better we suggest you ask yourself a simple question. The Union Budget announced a string of measures across several sectors that have had multiple impacts across companies in these sectors.
Are you the retail investor able to take a decision for yourself on which companies are positively/negatively impacted by the budget and which should now form/not form a part of your stock portfolio? Even if you are, we are sure you form part of a very small minority.
Also remember that the budget is just one such event, there are several other events taking place at the domestic and the global level that need to be continuously monitored. In other words, this is a full time job and if you give it anything less than your full time attention, you may well have a disaster on your hands.
Diversification is another strong imperative for investing in mutual funds. No matter how good an investor you are, it is unlikely that you will be able to summon the time, skill and expertise to accumulate and monitor at least 50 top stocks across at least 20 sectors so as to be very well-diversified at all times.
A diversified equity fund does that and does it well. Again, you may wonder why being diversified is such an imperative. It takes a prolonged bearish phase to answer that question. In such times, concentrated portfolios fall the hardest and, all and sundry begin scrambling to get more diversified.
For sheer innovation and objective-oriented investment, mutual funds are peerless. For instance, mutual funds are more suitable for helping you achieve your long-term goals of buying a house, child's education, daughter's marriage, retirement planning.
In fact, mutual funds have some specific funds for child's education, retirement planning, etc wherein investments are made with that mindset. You can't say the same for stocks.
Stocks are a means for mutual funds to achieve their long-term goals. Which brings us to a point we have stressed earlier, stocks are a potent investment avenue, but they need equally potent and dynamic fund management skills to steer them through a course that fulfills the desired investment objective.
Apart from objective-specific schemes, mutual funds also offer innovative plans like dividend options at monthly/quarterly/half-yearly intervals, systematic investment/withdrawal plans, automatic switching/rebalancing, et cetera.
These were some of the important benefits that mutual funds offer vis-à-vis stocks. Of course, they score over stocks on other counts as well like liquidity and economies of scale.
The moot point is that mutual funds are attractive because of the benefits they offer. These benefits are fundamental in nature and do not pale even a shade because of the presence/absence of tax benefits. So retail investors planning to 'return' to the stock markets, may want to evaluate this decision a little more objectively.