Monday, March 19, 2007

The Final Call

Work your Way up with your Wealth building Winners! (Contd.)

Performance Evaluation of Mutual Funds (contd.)

The Final Call

The option you select will be a function of your income requirement (although dividend income is not a guaranteed income), time horizon as well as the tax bracket that you are in. The option of whether to go for an equity fund or debt fund is a function of your risk appetite and asset allocation.

If you want to invest in an equity-oriented fund for less than a year, it is better to go for dividend payout or re-investment option as equity-oriented funds are exempt from dividend distribution tax (DDT). The growth option would be ideal if it is for more than a year since only short-term capital gains are taxed in the case of an equity-oriented fund.

Debt-oriented funds are not so simple, as you have to balance out between the capital gains tax and the dividend distribution tax.

If your total income falls below the minimum taxable limits, the growth option remains the more tax efficient option across horizons, because in the dividend option, you would suffer the incidence of DDT irrespective of your tax status.

If you are a tax payer and plan to hold a debt fund (money market or liquid fund) for less than one year and fall under the 10% or 20% tax slab, then go for the growth option as this will save you from the 28.3% dividend distribution tax, while your capital gains tax will be 11.3% or 22.6%. In case it is not a money market or liquid fund and you fall in the 20% tax bracket, the dividend option will be the best since DDT is only 14.125%. However, if you fall in a higher tax slab of 30%, then it would make more sense to go for the dividend payout or re-investment option, which will save you more on the capital gains tax of 33.9%, even after factoring in the dividend distribution tax of 28.3%(for money market or liquid funds) or 14.125% (for other debt-oriented funds).

As regards the long-term investment in a debt-oriented fund, it would be advisable to go for growth option. This is because the capital gains tax liability on such an investment will be the long-term capital gains tax rate of not more than 10% and you will not shell out the dividend distribution tax of 28.3% (for money market or liquid funds) or 14.125% (for other debt-oriented funds).

You researched your resources…systematically scouted for consistent performers with sound credentials…selected the right funds and the best option that maximizes returns. Now that the mirror on the wall has answered your question, you have your wealth-building winners ready for action….. actual investment. I shall deal with a disciplined approach to investing, that balances both risk and returns and builds wealth, in the forthcoming blog.

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