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How to reduce the number of funds in a portfolio and what would be its tax implications?

Dhirendra Kumar explains how one can streamline their portfolio and how the resulting LTCG would be taxed

I have investments in multiple funds of AMCs like Sundaram, Reliance, Franklin Templeton, DSP, ICICI Prudential, etc. As per your advice, I wanted to redeem these and streamline my portfolio by investing in only three-four schemes among flexi cap, mid cap and small cap. But I am concerned about the tax implications regarding the long-term capital gains accrued in the existing funds, which are more than five-ten years old and hence, would be significant. So will it be wise to switch to the new schemes or let the existing investment remain untouched, as they are performing average, earning neither very high nor very low returns, and once upon a time they have been top performers?
- Mr Dahiya

Firstly, your understanding that you'll be liable for capital gains tax, is true. But you will be liable for capital gains tax on your investments only for the gains earned since 1 February, 2018. All the gains before that are tax-sheltered and so, you are not liable to pay taxes on them.

For example, if you invested in a fund 10 years ago, and you invested at an NAV of Rs 10, and today its NAV has become Rs 20. But about three years back, as of 31 January 2018, if the NAV was Rs 17, then only the gains from that NAV will be liable for taxation, which is, Rs 3 only. The rules regarding this are pretty straightforward. Long term capital gains tax applicable is 10 per cent in case of equity investments held for more than one year and 15 per cent in case of gains for investments held for less than one year.

Secondly, there are advantages as well as disadvantages in the way you have held your funds. It is true that you are not liable to pay any capital gains taxes till the time you hold it. But the problem is, that you end up with a lot of funds, some of which are even 10-year-old, which could also be regular plans of the funds. So now, if you invest in direct plans, you would save here first on the expenses front.

The other is, that by virtue of investing in too many equity funds and as you've mentioned doing it in many AMCs, it would be around 15-25 funds and this is not something abnormal. This is quite usual, as many investors end up becoming collectors because you like some funds which were doing well when you invested. Subsequently, some other fund was doing well and you kept holding the old funds while investing in the new ones as well. So there is nothing unusual about it.

The real disadvantage is that by virtue of owning these many funds, you are actually having a portfolio that acts as an uncontrolled index fund. Your money is distributed all over the market and some funds would do well while some others don't, at any given point in time. So, the disadvantages of this fallout of your investment over time are, firstly, you are paying the cost of actively managed funds while you might inadvertently have an index-like portfolio. Index funds today have an expense of about 10 basis points. So why bear the cost of about one-two per cent when something of that kind is available at 10 basis points?

Secondly, it is entirely a matter of interest. Some people want to keep their things organised. The advantage of this is that you remain interested in managing your investment. Right now, if some of your investments do very poorly, you would say it is a very small amount which is invested there. If something does well, you feel happy. Generally, our attitude is such that we remember our wins and we tend to forget our losses.

So I would say that if you want to be on top of your portfolio, and want it to be better organised, it is good to have three-four good funds that can get you meaningful diversification and good management. Of course, it would warrant that you review and course-correct periodically. Because when you invest in anything which is market linked, you have to take some corrective action as and when they don't do well and maybe it is time to act.

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