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Moving from stocks to mutual funds: A tax-efficient guide

Things to keep in mind while navigating the transition

Moving from stocks to mutual funds: A tax-efficient guide

The stock market is a captivating world, particularly for passionate business enthusiasts. They delve deep into the intricate web of financial statements, market trends, and business dynamics. For them, it is a fulfilling journey beyond monetary gains. If you find yourself sharing this inclination, the world of direct stock investments could be your playground.

However, this may not be a cup of tea for everyone. Many may prefer a more hands-off approach. That's where mutual funds come in. They provide diversification and professional management for those seeking a hassle-free investment experience.

But what if you want to shift gears and move from stocks to mutual funds?

One of our readers is facing this dilemma. They currently hold stocks valued at Rs 25 lakh and are considering transitioning to mutual funds. They ask if they should make this leap all at once or spread it over time? Such queries reveal the conundrum investors face when they're at the crossroads of two distinct yet powerful investment avenues.

Navigating the transition

Moving a substantial corpus, like the Rs 25 lakh mentioned, from stocks to mutual funds isn't a decision to be taken lightly. It demands a well-thought-out strategy, especially one that ensures a tax-efficient migration.

Imagine you have five stocks in your portfolio, each with its own story:

Company Holding period Capital gain/loss
A 8 months Rs 12,000
B 1 year 5 months Rs 30,000
C 1 year 6 months Rs (25,000)
D 4 years Rs 1.35 lakh
E 5 years 1 month Rs 2 lakh

Here's how you can direct your money from these stocks into mutual funds in a tax-efficient way:

Strategic holding

Optimising returns begins with considering your holding durations. Stocks held for up to 12 months are subject to short-term capital gains tax at 15 per cent. However, if you can extend your holding period to more than 12 months, you'll benefit from the more favourable long-term capital gains tax rate of 10 per cent (with an exemption up to Rs 1 lakh).

So, don't be in a hurry to sell Company A. Even with a gain of Rs 12,000; wait a bit longer, and you'll pay only 10 per cent in taxes, rather than 15 per cent.

Balancing act

Another smart move is to 'set off capital losses.' This means you can adjust losses against profits, reducing your tax liability. Keep in mind that long-term capital losses can only be set off against long-term capital gains, whereas short-term losses can be set off against both long-term and short-term gains.

Take Company C, which suffered a loss of Rs 25,000, and Company B, which gained Rs 30,000. By strategically selling these stocks, you can offset the loss against the gain, resulting in a net capital gain of just Rs 5,000. Learn more about cancelling out capital losses .

Making use capital gain exemption limit

Companies D and E have substantial capital gains. Here's a tip: make use of the annual long-term capital gains exemption of Rs 1 lakh to reduce your tax burden. Selling Company D lets you fully utilise this exemption as the gain is Rs 1.35 lakh, thus reducing your tax burden to just Rs 3,500 (Rs 1.35 lakh - Rs 1 lakh and 10 per cent on Rs 35,000).

As for Company E, with its Rs 2 lakh gain, a strategic move might be to sell it in the next financial year so you can get another shot at the exemption.

Keep in mind that there is no rule mandating you to sell the stock entirely at once. You could also choose to sell up to Rs 1 lakh worth of long-term capital gains and further reduce your tax burden.

On your way to investing in mutual funds

Now you can invest the proceeds from these sales of stocks into mutual funds. Since this transition is within the equity realm, you don't need to opt for a systematic investment plan (SIP) to invest these proceeds. Instead, consider directing these funds as a lump sum investment into two to three flexi-cap funds of your choice. This approach offers an easier way to participate in the world of equities.

In the grand scheme of things, remember: don't rush! With a substantial corpus like Rs 25 lakh, maintaining tax efficiency at the heart of your strategy can significantly boost your returns. So, take your time, plan wisely, and watch your investments flourish.

Also read: Six popular tax-saving investments in India


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