Optimising tax efficiency with balanced advantage funds

IIndian investors pay close attention to taxes when making investment decisions. This is especially true for investors aiming to grow their wealth over the long run. While tax saving is not the sole objective of investments, choosing tax-efficient investment instruments is a strategic move. It allows investors to retain a greater portion of their potential returns, which can then be reinvested for potentially higher future gains. Balanced advantage funds (BAFs) are classified as hybrid funds and are a suitable investment option that can provide both equity taxation as well as diversification. By dynamically allocating assets between equity and debt, BAFs aim to generate a consistent long-term return potential while mitigating risks. Additionally, their tax treatment resembles that of equity funds if the equity allocation is over 65%, which further enhances their appeal.

This article discusses strategies for optimising the balanced advantage funds tax efficiency based on various factors like holding period, fund categorisation, and ongoing changes to tax laws.

• Table of contents

1. Understanding tax efficiency in balanced advantage funds
2. Strategies for optimising tax efficiency in balanced advantage funds
3. What are the risks of balance advantage funds?
4. Overview of Bajaj Finserv AMC's Balanced Advantage Fund

Understanding Tax Efficiency in Balanced Advantage Funds

Before delving into strategies, let us understand how BAFs are taxed based on their equity orientation. If the equity allocation in a BAF is 65% or more, it is categorised as an equity-oriented fund. In such cases:

• Long-term capital gains (holding period over 1 year): Long-term capital gains tax-exempt up to Rs. 1.25 lakh. Anything above this limit is taxed at 12.5%.
• Short-term capital gains (holding period less than 1 year): Attract a 20% tax.

This enables investors to enjoy the lower long-term capital gains tax rate, making BAFs tax efficient. However, if the equity allocation drops below 65%, the fund loses its equity status. Then, capital gains irrespective of the holding period are taxed as per the applicable income tax slab rates.

Strategies for Optimising Tax Efficiency in Balanced Advantage Funds

With this backdrop, here are some strategies that can optimise tax efficiency when investing in BAFs:

• Focus on equity-oriented BAFs: As discussed earlier, funds with over 65% equity allocation get preferred tax treatment. Hence, investors may prioritise equity-oriented BAFs to maximise tax savings opportunities. They should monitor equity exposures regularly and redeem from funds that fall below the 65% threshold.
• Invest for the long term: Since long-term capital gains are either tax-exempt or taxed at a lower rate of 10%, investors must hold their BAF investments for over a year to avail of this benefit. Opting for STP or systematic transfer plans can help maintain long holding periods. Investors can also use an SIP goal calculator to determine the appropriate monthly investment amounts, helping them adhere to their long-term investment strategies.
• Stay updated on tax regime changes: The Indian tax landscape keeps evolving. Investors must keep track of the Union Budget announcements and regulatory changes impacting equity/debt taxation or capital gains. Advanced planning allows one to maximize the potential benefits and reduce the tax outgo.
• Tax loss harvesting: Selling off loss-making units allows setting off gains, thus lowering the overall tax liability. However, investors must purchase back similar assets within 3 months to avoid wash sale adjustments. This strategy is suitable for experienced investors with adequate surplus funds.
• Evaluate periodic returns post-taxes: When selecting funds, evaluating not just pre-tax but post-tax returns over various periods (1, 3, 5, 10 years, etc.) is essential. This gives a true picture of how different funds have actually fared from a taxation perspective as well. A lumpsum mutual fund calculator can be a useful tool to estimate the potential returns of balanced advantage funds (BAFs) and compare them to other investment options. The calculator accounts for your investment amount, tenure and expected returns to project your potential final corpus. Do note, however, that the calculator's estimates are just an indication and there is no assurance that returns will be along expected lines.

What are the risks of balance advantage funds?

Balanced advantage funds, while aiming to provide balanced growth potential, carry certain risks. These include:

• Market risk: These funds still invest significantly in equities, exposing them to stock market volatility.
• Interest rate risk: The debt portion of the portfolio may be impacted by rising interest rates, potentially decreasing bond values.
• Complexity: The dynamic asset allocation strategy may be difficult to understand, especially for new investors.
• Management risk: Fund performance heavily depends on the fund manager’s ability to adjust allocations effectively; poor timing or sub-optimal allocation can impact returns.

Overview of Bajaj Finserv AMC's Balanced Advantage Fund

Bajaj Finserv Balanced Advantage Fund offers investors a dynamic route to potential long-term wealth creation. This open-ended fund aims to balance the potential upside of equities with downside mitigation through strategic asset allocation to fixed-income instruments and derivatives. While benchmarking against the NIFTY 50 Hybrid Composite Debt 50:50 Index, the fund actively adjusts its portfolio based on market conditions, catering to investors seeking long-term growth and dynamic asset allocation.

Conclusion

A balanced advantage fund's tax treatment depends majorly on its equity orientation. By judiciously employing the above-mentioned strategies, investors can optimise their BAF investments from a tax efficiency standpoint. Additionally, advanced tax planning can help channel more returns towards one's financial goals, with taxes taken care of optimally. Overall, a systematic and goal-oriented approach can unlock the potential of balanced advantage funds for wealth creation over the long run.

FAQs

How are taxes calculated in balanced advantage funds?

Balanced advantage funds are taxed based on their equity orientation. If the equity allocation is 65% or more, then the fund is considered equity-oriented and taxed as follows:

• Long-term capital gains: Gains exceeding Rs. 1.25 lakh on units held for more than a year are taxed at 12.5%. Gains up to Rs. 1.25 lakh are tax-exempt.
• Short-term capital gains: On redemption before one year, capital gains are taxed at 20%.

However, if equity allocation falls below 65%, then irrespective of the holding period, all capital gains are taxed as per the slab rates applicable to the investor.

What is the ideal holding period for tax efficiency?

The ideal holding period for maximising tax efficiency from equity-oriented balanced advantage funds is over 1 year. Gains earned from equity-oriented balanced advantage funds (with over 65% equity allocation) that are held for more than one year qualify as long-term capital gains. Those who are investing in a balanced advantage fund in lumpsum can consider using a daily compound interest calculator to estimate the potential returns on their investment. This can also help them calculate the possible capital gains on their investment and optimise their withdrawal strategy for tax-efficiency. Do note, however, that the calculator's projections are indicative and there is no gaurantee that returns will be achieved or will be along expected lines.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.