Dharmesh wants to know how to reduce his capital-gain tax while restructuring his portfolio. Here's what he can do.
02-Mar-2022 •Deepika Saxena
Dharmesh, 45, is a seasoned investor. He has been investing in equity funds for the past 20 years and has been able to accomplish several goals with the help of his investments. However, over the years, his portfolio has become cluttered with funds across various themes, sectors, market caps, etc., thereby making it difficult for him to manage it. He now wants to consolidate his portfolio and invest in a few good funds. But when it comes to restructuring a portfolio by selling some of the funds in it, one has to pay tax on capital gains. So, he seeks our help to reduce his capital-gains tax.
How many funds are enough?
At present, Dharmesh is investing in 15 funds, including two tax-saving, two small-cap, three mid-cap, three thematic, three flexi-cap, one value and one large-cap fund(s). Ideally, an investor should not invest in more than four-five funds.
For most investors, investing in two-three flexi-cap funds and one-two tax-saving funds is enough. Also, for proper asset allocation and rebalancing, one should also invest in one-two short-duration debt funds.
Flexi-cap funds invest across the market-cap segments and sectors and therefore provide investors with adequate diversification. Tax-saving funds, or equity-linked savings schemes (ELSS), are also managed in a flexi-cap style. One can invest up to Rs1.5 lakh in these in a financial year and get tax exemption on that amount.
These days many investors also want international diversification, so one can explore adding one-two international funds and investing not more than 25 per cent of your corpus in these. Do note that some flexi-cap funds have also started taking a measured exposure to international equity, so those could be explored as well.
Investing in mid- and small-cap funds is entirely optional and one should do so only if one is willing to take extra risk for extra returns. Also, the exposure to mid and small caps should not be more than 20-25 per cent of the portfolio.
The subscribers of Value Research Premium can refer to the Analysts' Choice section to see the best funds in each of these categories.
How Dharmesh can reduce the number of funds in his portfolio
Dharmesh can do the following to cut the number of funds in his portfolio:
Reducing the tax liability
Dharmesh should not exit the undesirable funds at one go. Instead, he should make the transition smartly and gradually. Also, he should be aware of the exit load. It is better to wait until a fund becomes exit-load-free.
Dharmesh has long-term capital gains of Rs2.5 lakh. As we stand on the cusp of two financial years, there can be no better time to make changes in his equity portfolio. Long-term capital gains on equities up to Rs1 lakh are exempted in a financial year. So, if the gains on his investment are more than Rs1 lakh, he can split these gains between this and the next financial year. A few weeks from now, the new financial year (FY2022-23) would begin, which would automatically refresh his Rs1 lakh exemption limit. This way, Dharmesh will be able to enjoy an exemption limit of up to Rs2 lakh.
If he redeems the desired amount in this financial year (FY 2021-22), he would need to pay a long-term capital-gain tax of Rs15,000. On the other hand, if he breaks his investments between this and the next financial year (assuming that capital gain in each year is Rs1.25 lakh), he would be required to pay a tax of Rs5,000 (see illustration 'Reducing tax liability').
Dos and don'ts of managing a portfolio
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