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Strategy to reduce the number of funds from 30 to 6

Ashutosh Gupta outlines the strategy to cut down the number of funds in a portfolio.

What should be the strategy to reduce the number of funds from 30 to 6, considering the implications related to tax and exit load? Most of them are giving good returns.
- Somen Mondal

A lot of investors get concerned about the capital gains-tax liability when they are looking to switch their investments from one fund to another. In fact, in our Premium account, we advise our subscribers to move their investments from regular to direct plans and many of them express their concern about the applicability of the capital-gains tax.

The thing about the capital-gains tax is that you can at best defer it but you can't wish it away, because at some point in time, you will have to sell those investments to realise the money and whenever you sell it, the capital-gains tax incidence will arise. Thus as I said, you can at best postpone the capital-gains tax but you can't wish it away. But that doesn't mean that you keep saddling yourselves with capital-gains taxes by needlessly jumping from one fund to another frequently. But having said that, if there are certain other ways in which this postponement is hurting you, then you should definitely switch your funds even at the expense of capital-gains tax liability.

For instance, by postponing your switch from regular to direct plans, you keep incurring higher expense ratios or higher annual costs of the regular plans. Likewise, in your case, by continuing to run a large portfolio, you are letting inefficiencies creep in, which itself can impact your returns adversely because you simply end up owning the entire market.

However, try and make those transitions smartly and gradually instead of doing all of them at one go. You can use some tactics that you can deploy to optimise your capital-gains tax liability while you make these switches. For instance, exit load is one consideration that you should pay attention to and if by postponing your switch by a few months your investments can become load free, then it should be worthwhile to wait.

Similarly, try and spread your transitions over at least two financial years so that you can derive the benefit of the threshold exemption from capital-gains tax up to Rs 1 lakh for two financial years.

Also, look out for opportunities from steep market corrections. That's when a lot of capital-gains tax temporarily gets eroded and if you make those switches at that time, then it tends to reduce your capital-gains tax liability.

Now to address the second part of this issue, which is - how to go about picking the funds that one should prune down when one is running such a large portfolio. So, I would broadly suggest that go by a few thumb rules. First is to get rid of any sector or thematic funds that you hold. Second could be to look out for other supplementary-type allocations which are in a dominating allocation in your portfolio. So for instance, check how much allocation you have in small- and mid-cap funds and if that is very high, then those could be some of the investments that you can look to exit from.

The other thing you should check is how you are placed from the perspective of diversification at the fund-house level. If a particular fund house is far too dominant in your portfolio, for instance it accounts for more that 35-40 per cent of your investments, then that is another cue for you to prune down and make your portfolio better diversified at an AMC level.

Finally, look for any small and insignificant holdings, say funds that account for less than 5 per cent of your overall portfolio. Because even if these funds become blockbuster tomorrow, it is not going to have a material impact on your returns. So, either you should look to increase allocation or increase their weightage in your portfolio by investing in them the money that you would have realised by exiting some of the other funds or you exit these funds altogether. These are some of the thumb rules that you can use as you go about cutting down the number of funds in your portfolio.

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