Investors have realized that equity mutual funds are one of the good investment options which aim for long term wealth creation. The benefits of investing in equity mutual funds are as follows:-
As mentioned earlier, mutual funds aim to outperform the market index and generate superior returns for investors over sufficiently long investment horizons. Experienced fund managers have the ability the identify stocks with higher earnings growth potential or stocks which are available at a discount to their intrinsic value or stocks with high earnings growth potential trading at a reasonable price.
In addition to superior stock selection, fund managers can also be overweight / underweight in certain industry sectors relative to the market index based on their outlook for different sectors. By being overweight on sectors which have higher growth potential, fund managers can outperform the market. From time to time fund managers also book profits in stocks which they think have become expensive. These profits can be distributed to investors as dividends (in dividend options) or re-invested in the scheme (in growth option).
Apart from wealth creation potential, equity mutual funds are one of the most tax efficient investment options. Income from traditional investment options like bank FDs and many Government (Post Office) small savings schemes are added to the income of the investor and are taxed according to the income tax rate of the investors. In mutual funds incidence of taxation arise only on redemption or dividend pay-out. There is no taxation during the period you remain invested in the scheme unlike bank FDs.
Capital gains in equity funds held for less than 12 months (short term capital gains) are taxed at 15% plus applicable surcharge and cess. If your holding period is more than 12 months, then long term capital gains of up to Rs 1 lakh is tax exempt. Long term capital gains in excess of Rs 1 lakh in a financial year are taxed at 10% plus applicable surcharge and cess. Lower rate of capital gains taxation makes equity funds one of the most tax efficient instruments.
Prior to this financial year (FY 2020-21) dividends paid by mutual funds were tax free in the hands of the investors, but the scheme had to pay dividend distribution tax (DDT) before paying dividends to investors. From this financial year (2020-21), the Government has abolished dividend distribution tax (DDT) and dividends will be treated as income in hands of the investors. In other words, dividends will be added to your income and taxed according to your income tax rate. Investors should understand the tax consequences of their investments and make informed decisions.
In the last 20 years (1st May 2000 to 30th Apr 2020) Rs 1 lakh invested in Nifty 50 TRI would have grown to Rs 9.75 lakhs. The chart below shows the extra wealth creation for every additional 50 bps of alpha.
Historical performance of top performing equity mutual funds across different category has shown consistent alpha creation over long investment horizons. In addition to wealth creation potential equity mutual funds are also one of the most tax efficient investment options. You should review your investments and see if you have adequate investments in equity funds to meet your long term financial goals.
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