How to Build a Mutual Fund Portfolio
The journey of generating wealth begins with a simple sound financial decision that is picking out your funds, Just as a skilled architect meticulously selects the right materials and designs to construct a sturdy structure, investors must carefully create their mutual fund portfolio to align with their objectives.
A well-diversified portfolio of mutual funds can provide a stable and consistent return on investment, while also minimizing risk. In this blog, we will explore the key steps and strategies involved in constructing a successful mutual fund portfolio.
Understanding Tax Harvesting for Mutual Funds
Tax harvesting for mutual funds involves selling mutual funds at a loss to offset capital gains from other investments, thereby reducing the overall tax liability. This strategy takes advantage of specific tax provisions that permit the adjustment of losses against gains. Additionally, investors can employ a strategy of booking profits up to Rs. 1 lakh and buying back the same or similar investments. Since gains up to Rs. 1 lakh are exempt from taxes, this approach effectively makes profits tax-free, akin to the concept of wash sales.
Common Tax Harvesting Strategies in Mutual Funds
Selling Under performing Mutual Funds
One such easy way to harvest tax is selling mutual funds that have underperformed. By realising these losses, investors can counterbalance gains from other investments which in turn reduces their taxable income. This practice is often carried out towards the end of the financial year to reduce losses for tax purposes.
Switching Between Mutual Fund Schemes
Another such method involves switching between mutual fund schemes within the same fund house. By moving from a scheme with long-term losses to another scheme, investors can realise these losses against other gains wherein the investor reduces his taxable income while also remaining invested.
Utilising Wash Sales
A wash sale entails selling a mutual fund at a loss and then repurchasing it shortly after. This allows investors to book losses for tax purposes while also maintaining their investment position. Although effective, this strategy must be used cautiously to avoid unwarranted inspection from the tax authorities.
Section 112A
Section 112A deals with Long-Term Capital Gains (LTCG). If the LTCG exceeds Rs. 1 lakh from the sale of listed equity shares, equity-oriented mutual funds, or units of a business trust, a 10% tax is applied without indexation benefits. This tax applies only if the Securities Transaction Tax (STT) was paid during both the transfer and acquisition in specific scenarios. Adding on this is only applicable if the equity shares or funds are sold after being held for longer than a year
Practical Application of Tax Harvesting
Investors should apply tax harvesting responsibly to avoid penalties. Here are some practical tips:
- Review Your Portfolio Regularly: Assess your mutual fund investments periodically to identify underperforming funds that could be sold for tax harvesting.
- Plan Ahead: Implement tax harvesting strategies towards the end of the financial year to maximise benefits.
- Understand the Rules: Familiarise yourself with the relevant tax laws to ensure compliance and avoid potential pitfalls.
- Consult a Financial Advisor: Professional advice can help tailor tax harvesting strategies to your specific financial situation and goals.
Conclusion
Tax harvesting is a valuable tool for managing tax liabilities within a mutual fund portfolio. By understanding and applying the relevant tax provisions, investors can strategically manage their investments to optimise their tax outcomes. As with any financial strategy, it is crucial to execute tax harvesting responsibly and in compliance with the law to reap the full benefits without facing penalties.
