Investors have always looked for ways to optimise their investments and minimise tax liabilities. One popular investment avenue has been debt mutual funds, known for their relatively lower risk and potential for stable returns.
However, recent changes in tax regulations have impacted the attractiveness of debt funds. This has led many investors to explore alternative options, such as equity savings funds, which provide a potential solution to mitigate the tax burden.
How?
Let’s find out!
Understanding Debt Mutual Funds and Tax Implications
Debt mutual funds primarily invest in fixed-income securities like government bonds, corporate bonds, and money market instruments. Historically, these funds have been a popular choice for conservative investors seeking stable income and capital preservation.
One of the advantages of debt funds was their favourable tax treatment, particularly for investments held for more than three years. However, the Union Budget 2023 introduced a change in the tax treatment of debt mutual funds.
The indexation benefits that accompanied long-term investments have been completely done away with. In the current scenario, no matter what the holding period is, debt funds will be taxed according to your income tax slab.
In light of this announcement, more and more investors are starting to look for alternatives.
What are Equity Savings Funds?
Equity Savings Funds are hybrid mutual funds that aim to provide investors with a balanced portfolio by diversifying investments across equities, debt instruments, and arbitrage opportunities. These funds typically allocate a significant portion of their assets to equities (ranging from 20% to 40%), with the remainder invested in debt and money market instruments.
“Equity savings fund is the least volatile category, which carries equity taxation, that is, LTCG at 10 percent and STCG at 15 percent, among all the hybrid funds.” — Vinayak Magotra, Centricity Wealthtech
In other words, these funds offer the best of both worlds — less volatility along with taxation benefits.
Considering the Tax Hit: Is it Worth Investing in Equity Savings Funds?
The tax hit on debt mutual funds has undoubtedly impacted their attractiveness to investors. However, whether equity savings funds are a suitable alternative depends on various factors, including an individual’s risk appetite, investment horizon, and financial goals. Here are some points to consider when evaluating the viability of ESFs:
- Risk Profile: While ESFs offer the potential for higher returns through equity exposure, it’s important to note that they carry a certain level of risk due to their equity component. Investors with a conservative risk profile may need to assess their risk tolerance before allocating funds to ESFs.
- Investment Horizon: They are ideally suited for medium to long-term investment horizons. Short-term market volatility may affect the performance of these funds. Investors should align their investment horizon with the objective of the fund.
- Diversification: ESFs provide a diversified portfolio by investing across equities, debt, and arbitrage opportunities. This diversification helps in spreading the risk and potentially reducing the impact of market volatility.
The Verdict
So far, equity savings funds have not been the most popular among hybrid mutual funds. As per the latest data from AMFI, the total AUM under these funds was ₹16,012 crores. In comparison, the category leader — Balanced Advanced Funds — reported an AUM of ₹1,91,809 crores.
But that was before.
Going forward, we can expect the popularity of equity savings funds to grow in future. They offer a potential solution by diversifying investments across equities, debt instruments, and arbitrage opportunities. With their tax advantages, including a lower tax rate on long-term capital gains and reduced dividend distribution tax, ESFs can be an appealing choice for investors seeking a balance between growth and stability.
