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Penny wise, Budget foolish

Making yearly changes to your portfolio to counter Budget provisions is a losing strategy

Penny wise, Budget foolish

Every year, after the finance minister is done with chopping and changing the tax rules in the Budget, some investors get into hyperactive mode.

This year too, after the Budget changes, queries have been pouring in. 'Now that ELSS funds have been made taxable at redemption (exempt-exempt-taxed), should I switch to ULIPs or PPF instead?' 'Given that interest from bank FDs is exempt up to Rs 50,000 a year, should I redeem my debt funds?' 'Given that the grandfathering clause needs me to maintain records of my January 31 NAVs, why shouldn't I sell all my equity funds and buy them back before April 1?'

Not just taxation
Well, all of the above are bad ideas because they miss the wood for the trees. When you decide to bet your money on any new investment option, you must be considering a whole bunch of factors to make the choice. 'What's my goal and when do I need the money?' 'How much returns will I get?' 'What's the risk I can take?' 'What's the exit option available to me if this investment doesn't deliver?' And then, of course, 'how tax efficient is this investment?'

In short, any good investment choice is made after considering five key parameters - safety, returns, liquidity, costs and taxation. Then why get jumpy and make hasty portfolio changes when just one of those factors - the taxation - changes? Even if an instrument has become marginally less attractive on taxation, don't the other investment arguments remain the same?

Take ELSS funds. When investors chose an ELSS over a ULIP, they were probably going by the scheme's track record, their ability to compare the fund's returns to peers, exit after three years if the scheme underperformed and its transparency on costs and returns.

Now, the fact that their final redemption proceeds from the ELSS will attract a 10.4 per cent long-term capital gains tax, after grandfathering of past gains, doesn't really take away from these other pluses of ELSS. ULIPs, despite a better tax treatment, continue to demand a longer lock-in (five years) and offer lower transparency on costs and returns. They also carry an insurance component that the investor wasn't even looking for. So why make the switch?

If rewinding your carefully thought-out investment choices just to save on tax is unwise, jumping in and out of asset classes just to save on paperwork is an even more dubious practice. Given the many years it must have taken any investor to put together a performing portfolio of equity funds, selling all of it in one go, in not-so-conducive markets, just to skip paperwork appears quite foolhardy. While selling may be easy enough, think of how much effort it would take to rebuild the entire portfolio brick by brick? Then there would be the transaction costs and risks of market timing, too. What if, in your efforts to reboot your portfolio now, you miss out on a big market rally?

Competing with the FM
To some people, evading the taxman's axe is like a game of chess. Every time the FM changes the tax rules, they're ready with a clever new strategy to switch around their investments to side-step the new tax. But apart from contributing to high portfolio churn with its accompanying costs, such moves can really take a toll on their investment returns.

The FM has an unlimited free pass to change the tax laws as many times as he wishes. In fact, every such change makes perfect sense for him because he can bump up his tax collections and it costs him nothing. But trying to outplay him in this game can cost you dear in terms of transaction costs, taxes and very sub-optimal returns.

Overcomplicating it
There are others who complicate their life by splintering their portfolios to stay off the taxman's radar. Spreading one's investments across one's family, 'gifting' sums to relatives to avoid tax dues, owning multiple bank accounts to escape filing tax returns - all of these strategies may have helped evade tax until a few years ago, when the taxman relied on manual methods to nab tax evaders.

Today with Big Data and Aadhaar linking of PAN numbers, such evasive tactics can be sniffed out in a trice. Not only is there a good chance of being caught by the taxman, overcomplicating one's portfolio will likely detract from the basic objective of investing - earning a good long-term return. Keeping track of one's portfolio is difficult enough without spreading it thin over dozens of vehicles.

Wrong choices
Some investors make investment choices that are quite unsuitable or plain unattractive, just to save on taxes. A classic example here is that of young people who have just embarked on their career and are buying property and taking on gigantic home loans, just to avail of the interest-tax breaks on these loans.

Locking into a 10 or 15-year EMI to finance an illiquid and immobile asset at the very start of their career oftentimes proves a big burden on their finances, decimates their savings and hampers career mobility as well. Similarly, unwise is the decision to commit to high premiums for 10 or 15 years on traditional insurance plans that return peanuts just to avail of their tax breaks.

Then there are those investors who let their entire portfolio be driven by the approved list of investments under Section 80C of the Income Tax Act. No matter how attractive or suited to their risk profile an investment outside this list is, they wouldn't give it a second look because it carries no tax breaks.

In such cases, what investors don't realise is that the opportunity loss on returns from the wrong vehicle often wipes out the tax savings many times over. It's a classic case of being penny wise and pound foolish.

So next time, the FM comes up with a new tax proposal in the Budget or outside of it, don't rush to rejig your portfolio. It is your financial goals, your risk profile, your return requirements and your investment horizon that should decide your investment choices. Don't let the FM take control of these.