Equity savings vs Conservative hybrid: The better option

Similar looking funds, differing post-tax returns

equity-savings-vs-conservative-hybrid-the-better-option

Imagine a scenario where two hybrid funds invest one-third of their portfolios in equity stocks but are taxed differently. This is precisely the case with Equity savings and Conservative hybrid funds.

Here's why:

This is the construction of an equity saving fund:
33.3 per cent in equity + 33.3 per cent in debt + 33.3 per cent in arbitrage

Here's the portfolio construction of a conservative hybrid fund:
10-25 per cent in equity + 75-90 per cent in debt

Technically speaking, all mutual funds with less than 35 per cent equity allocation have a harsher tax.

In such cases, your gains are added to your income and then taxed as per your tax bracket. For example, the profit on your mutual fund investment will be subject to a 30 per cent tax if your total income for the year crosses Rs 10 lakh (old tax regime) or Rs 15 lakh (new tax regime).

By that logic, equity savings funds should also be subjected to this tax structure.

But it's not.

Since these funds dabble in arbitrage opportunities, they are taxed differently - and leniently.

Hence, your gains up to Rs 99,999 are not taxed at all.

If they exceed Rs 1 lakh, the gains are taxed 10 per cent only.

In the worst case scenario, the Rs 1 lakh-plus gains are taxed at 15 per cent only if you sell the fund within a year.

Head to head post-tax returns
Let's say an investor puts Rs 10,000 via a systematic investment plan (SIP) in both Equity savings and Conservative hybrid funds for five years, assuming both funds generate a 10 per cent return. Despite identical investment and returns, the post-tax presents a different story.

	Equity savings fund	Conservative hybrid fund
SIP investment	Rs 10,000	Rs 10,000
Value after 5 years	Rs 7,80,824	Rs 7,80,824
Gains	Rs 7,70,824	Rs 7,70,824
Tax treatment	10 per cent	Taxed as per your slab, assuming 10 per cent
Tax	Rs 67,082	Rs 77,082
Net returns	Rs 7,03,741	Rs 6,93,741

Equity saving funds win hands down.

What's more, if we assumed that the investor fell in the 30 per cent tax bracket, the difference would have been even starker - Rs 1,64,165, to be precise .

The last word
Both conservative hybrids and equity saving funds are hybrid funds best known for their stability.

But the post-tax returns make equity saving funds the clear winner.

And we haven't even taken the 5- and 10-year returns into consideration. Conservative hybrids' slightly higher ten-year returns will evaporate if you take tax into consideration.