Investing in balanced funds? Look beyond tax gains

The objective of these funds is to provide capital growth via a mix of equity and debt: blend of growth and safety. Balanced funds invest around 70% of the money in equities and rest in bonds.In the recent past, mutual fund assets have grown significantly. The highest percentage growth has been in Balanced Funds.

The reasons for this growth are as follows: (a) equity valuations being stretched, the exposure to the market is defensive as compared to 100% equity exposure (b) tax efficiency is same as that of equity funds and (c) regular dividends.

The correct perspective

Let us look at the three reasons mentioned above. The first rationale is, asset allocation done by the fund manager without the investor doing it himself , which has the advantage of discipline, i.e., the fund manager does the portfolio rebalancing from time to time. The second rationale is what we will discuss now, on tax treatment after the Union Budget and revised taxation of equity funds. The third reason, regular dividends, goes against the grain of long-term growth-oriented investing. A market growth-based investment, meant for the long term, should be differentiated from a Post Office Monthly Income Scheme; it is not meant to give regular dividends. If you require regular cash flows, you should do your financial planning accordingly.

Taxation rules

The current tax treatment, valid till March 31, 2018, is that dividends from Balanced Funds are tax-free, i.e., there is no dividend distribution tax (DDT). The Union Budget has changed it effective April 1, 2018; there is a DDT of 10% plus surcharge and cess, i.e., 11.65%. As against this, the DDT rate on debt funds, with marginally increased cess from April 1, is 29.1% for individuals and 34.94% for corporates. Let us now compare the current tax efficiency of Balanced Funds with the revised one applicable from April 1, 2018. Let us say, there is a dividend of Rs 100 paid out by a Balanced Fund, and the allocation of the fund is 70% in equity and 30% in debt. Currently, DDT is nil. As against this, if the allocation is made as 70% in an equity fund and 30% in a debt fund, the DDT would be (70 x 0) plus (30 x 28.84% for individuals) = Rs 8.65 for individuals. That is, the tax efficiency in Balanced Fund over focused allocation is 8.65%. Now we will see how it looks in the revised scenario. The DDT in the Balanced Fund will be Rs 100 x 11.65% = Rs 11.65. The DDT in the focused allocation will be (70 x 11.65%) plus (30 x 29.1% for individuals) = Rs 16.86. Hence, the tax efficiency in the Balanced Fund over focused allocation is (Rs 16.86 – Rs 11.65) = 5.23%. There will be a tax efficiency, but to a lower extent, i.e., 5.23% vis-à-vis 8.65%, under the assumptions.

The crux of the matter is, investments should be decided on fundamental parameters, i.e., what the investment is worth. Tax efficiency is relevant as an additional parameter, not as the sole decision criterion.

Finally, find out where the fund manager invests both in the equity and the debt portfolio. As an investor you need to decide which style suits your portfolio. Also find out where the fund manager puts the money in the debt portion.