it viable to invest in equity funds? Dhirendra Kumar looks
for an answer keeping in mind the Budget implications
where do I put my money? asks Mukesh Khanna, a Mumbai-based
entrepreneur. Many investors like Khanna will have to rethink their
strategy for making investments, courtesy Yashwant Sinha. The Union
Budget 2002 has some serious implications for a tax-paying investor.
Although dividend distribution tax on funds has been abolished,
the dividend is no longer a tax-free income in the hands of investors.
Henceforth, dividends will be taxed at the marginal rates of taxation
applicable to the investors. A considerable hike for investors in
the higher income tax brackets. Further, equity funds have been
brought under the tax net. Dividends of equity funds will now be
charged at a flat rate of 10 per cent.
the first instance, it appears that the current Budget announcements
have rendered mutual funds an undesirable investment option. But
the way out is a switch to the growth option as against the dividend
option of the funds. This saves the investor from the nuisance of
a dividend tax. At the same time, the investor can continue to have
a steady source of income via the Systematic Withdrawal Plans (SWP)
of the growth options of these funds. However, equity funds continue
to be significant for long-term investors for reasons more than
The Right Choice
Before moving any further, let me present a case for equities as
for most investors who boarded an equity fund early last year, things
look depressing. And the follow-up is the fight to safety, clearly
reflected in the preference for fixed income alternatives. This
preference shift is understandable, but may not necessarily be correct.
is a volatile asset class. But volatility and performance over a
brief period may not be a risk. Measuring performance and the ups
and downs of an asset - its price volatility - over a period of
one or two years can be misleading, when as an investor you have
a time horizon that can be as long as 10 or 20 years. In this context,
the most compelling risk we all face is inflation. The ups and downs
of stock or bond prices pale against the slow (and sometimes rapid)
loss of purchasing power.
What we really have is existential risk, the risk that inflation
and taxes will erode the purchasing power of our savings. A realistic
definition of risk should measure investments in two ways - the
probability that the investments you choose will preserve your capital
over the investment time frame and the probability that the investments
you select will outperform alternative investments for the period.
this context, equity may not be the highest risk investment. It
will be investment in cash, bonds and bond funds, which are most
likely to lose purchasing power over time. By investing your long-term
savings in fixed-income option, your greatest risk may be not taking
one with equities, as no other security class can match the long-run
returns available from stocks. And the diversified equity funds
still hold promise. They reduce your risk and diversify your portfolio.
Simply put, these funds build a portfolio of stocks, chosen from
various sectors and reduce the risk associated with a particular
Is The Key
For the uninitiated, diversified equity funds could also be the
stepping stone into the world of equities. The portfolio of a diversified
equity fund includes securities that are not affected by the same
set of variables.
instance, information technology, pharmaceuticals, consumer goods,
cement and aluminium are completely different businesses. Depending
on the economy, the trick is to find stocks that do not move in
tandem at the same time.
of funds concentrated in few sectors. Dont count on them as
sectors rotate. And they usually make their most abrupt changes
just when investors have concluded that a new permanent order has
set in. The best way to avoid being caught in rotation is to stay
diversified - and to rebalance. Hence, it is important to pick up
a truly diversified, yet actively managed equity fund. An actively
managed fund will also ride the opportunities thrown up by a particular
sector while being prudent with its exposure limits.
Diversified equity funds are vehicles for long-term wealth creation,
spanning over at least five years and more. Hence, before jumping
onto the equity fund wagon consider your objective and the time
you have. Then evaluate the fund investment strategy. This is easily
decoded with the funds sector allocation. After taking into
account the return consistency, the allocation to various sectors
and stocks, you would have a fair indication of the funds
diversification. And if the fund changes its investment strategy
during your stay, one should reconsider whether the realigned strategy
is within your comfort level.
take from diversified equity funds includes Kothair Pioneer Bluechip,
Sundaram Growth and Zurich India Capital Builder for being truly