In today’s Finshots, we explain the latest googly the Indian government has thrown at the mutual fund industry.

The Story

“Invest in debt mutual funds. They are more tax-efficient than your fixed deposits.”

That is every (almost) financial expert’s sales pitch to a rookie investor. And the conversation would go something like this.

Expert: Say you invest money in an FD that gives you 7% return. It sounds pretty good. Till its time to pay tax. Tell me, what tax slab do you fall into?

Rookie: 30%. 🙁

Expert: Well, then you have to pay a 30% tax on that FD return. So effectively, you earn only 4.9%.

Rookie: Yikes. That sounds bad. It doesn’t even beat inflation. I’m actually losing money!

Expert: And that’s why you should invest in a debt mutual fund. It’ll earn you a higher return than an FD. But ignore that. Let’s assume a return of 7% itself. It’ll be easier to compare. Now, if you sell this investment after 3 years, you don’t need to pay 30% tax. You pay only 20%.

Rookie: That’s great.

Expert: But wait…I haven’t told you the best part yet. You don’t pay tax on the 7% return. You can make an adjustment for inflation. It’s called the ‘indexation benefit’. So if inflation is 5%, then your real gain is only 2%. You only pay tax on that tiny bit of ‘excess’ returns. If you do the maths, your actual return after tax is 6.60%!!! You beat inflation comfortably.

Rookie: Wow! Sign me up already. But…are these mutual funds safe?

Expert: Okay, I know what comes to your mind when hear the words ‘mutual fund’. The disclaimer, right? The one saying “Mutual fund investments are subject to market risk. Read the offer document carefully before investing.”

Rookie: Yup.

Expert: Okay, that’s a bit scary because we immediately imagine a stock market crash and our investments getting wiped out. But, not all mutual funds invest into the stock market. There are other kind of mutual funds too. Ones that don’t invest in stocks. Rather, there’s a professional fund manager who takes your money and then loans it to other companies. Or even to the government. They give it out as a form of debt. They could loan this money for a few days or a few years. So yeah, it’s not that risky..

Rookie: Well, sign me up then. Debt mutual funds it is!

***

Well, 31st March 2023 is probably the last time you’ll ever hear such a conversation again.

Why’s that you ask?

Because the government, out of the blue, had just scrapped this indexation benefit that debt mutual funds enjoyed.

On Friday, very furtively, they snuck this rule change into the Finance Bill. And passed it in the Parliament. No one saw this coming. There was no hint of this in the Budget Speech in February where such things are typically announced. There were no talks about this in any interviews during the past couple of months, nothing. With just a week to go before the end of the financial year, the government simply decided to kill this taxation advantage.

They’re saying, “Look, we’ll give you time till the 31st of March. Whatever investments you make before then will be taxed as per the old rules. You’ll get indexation. But from April 1st onwards, any new investment will be taxed as per your slab. Whether you invest and sell it in 1 month or 10 years.”

Now this is a bit of a shocker. Because it’s going to hurt a lot of people.

For starters, this will hurt investors like you and me who park money for the long term to get relatively safe returns and beat inflation comfortably. Without indexation, we might consider moving to FDs. And after paying our taxes, our investments may not beat inflation anymore. We’ll lose money.

It’ll also hurt financial experts who earn money when their clients invest in such funds. They might have earned via commissions. Or they might have charged a perentage fee directly from the client for doling out advice. Now, if clients simply prefer investing in an FD, that’s a knock for the business prospects of these advisors.

It’ll hurt the mutual fund industry too. According to CLSA, roughly ₹8 lakh crores is invested in these debt mutual funds. And 11–14% of the revenues that mutual fund companies make come from the fee they charge on these products. If they don’t see this pie growing from here on, their revenues won’t grow at the same pace either.

But that’s not all.

It’ll hurt the corporate bond market too. What we mean is that a lot of companies borrow money from these debt mutual funds. They issue bonds which the mutual funds buy. Basically, mutual funds compete with banks to lend money to these companies. And often offer a better deal. The company gets to borrow from the market at a lower rate. But if investors shun debt mutual funds, then companies will have no option but to go to banks for their borrowing needs again. And since banks don’t have to compete with anyone for lending this money anymore, they could even charge a higher interest rate from the company. Who knows. It could happen.

But there’s one more thing. The government might actually be shooting itself in the foot with this move as well.

You see, in 2019, the government launched something called the Bharat Bond Fund. Think of it as a debt mutual fund. But it would only contain bonds issued by government-backed companies like the National Highways Authority of India (NHAI) and Power Finance Corporation (PFC). They’d raise money from people like us. And use that to fund their long-term projects.

Everyone loved the Bharat Bond Fund. The government launched a series of them and mopped up over ₹50,000 crores. They even said how proud they were of its popularity among investors.

Now here’s the thing. Investors chose these funds primarily for two reasons. It was a ‘target maturity fund’. So, if you knew that you didn’t need the money for 10 years and wanted it kept safe, you would invest in it. The yield you’d see when you invest would pretty much be what you would get. There was certainty associated with the returns. And more importantly, there was this huge tax benefit due to indexation.

Now, it won’t have that tax benefit anymore. And when the government tries to launch more such Bharat Bond Funds, they may find that the takers have dried up.

So yeah, this random change in tax rules could have quite the ripple effect for now.

But it’s not all game over. Maybe the mutual fund industry will band together and lobby hard to scrap this rule. Maybe they’ll win. Maybe they won’t. We don’t know.

And if the only thing the government wanted was to level the tax playing field between debt mutual funds and FDs, they could’ve done it differently. Maybe they could’ve allowed people to adjust for inflation in their FDs instead? Help people beat inflation instead of killing whatever little options they had.

Until then…there really aren’t too many solutions. You just have to live with it. And it all boils down to this — if you’re someone who likes to play it safe and wants to simply park money in a conservative product to beat inflation, then good luck to you. Finding such a product will be like finding a needle in the haystack.

Until then...

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Ditto Insights: Why Millennials should buy a term plan

According to a survey, only 17% of Indian millennials (25–35 yrs) have bought term insurance. The actual numbers are likely even lower.

And the more worrying fact is that 55% hadn’t even heard of term insurance!

So why is this happening?

One common misconception is the dependent conundrum. Most millennials we spoke to want to buy a term policy because they want to cover their spouse and kids. And this makes perfect sense. After all, in your absence you want your term policy to pay out a large sum of money to cover your family’s needs for the future. But these very same people don’t think of their parents as dependents even though they support them extensively. I remember the moment it hit me. I routinely send money back home, but I had never considered my parents as my dependents. And when a colleague spoke about his experience, I immediately put two and two together. They were dependent on my income and my absence would most certainly affect them financially. So a term plan was a no-brainer for me.

There’s another reason why millennials should probably consider looking at a term plan — Debt. Most people we spoke to have home loans, education loans and other personal loans with a considerable interest burden. In their absence, this burden would shift to their dependents. It’s not something most people think of, but it happens all the time.

Finally, you actually get a pretty good bargain on term insurance prices when you’re younger. The idea is to pay a nominal sum every year (something that won’t burn your pocket) to protect your dependents in the event of your untimely demise. And this fee is lowest when you’re young.

So if you’re a millennial and you’re reading this, maybe you should reconsider buying a term plan. And don’t forget to talk to us at Ditto while you’re at it. We only have a limited number of slots everyday, so make sure you book your appointment at the earliest:

1. Just head to our website by clicking on the link here

2. Click on “Book a FREE call”

3. Select Term Insurance

4. Choose the date & time as per your convenience and RELAX!