Why you should go for long term equity MF Investments

The tax structure for the gains on equity mutual funds is clearly beneficial to investments that are of long term in nature. The difference in tax rates for short and long term investments may not look big in absolute terms. But when one takes into account the actual tax outgo, this differential tax rates mean a lot of saving for the long term investors in equity mutual funds. Hence it is all the more important to understand how the taxation of equity mutual fund works and how one benefit from the same. 

Nature of gains 

In terms of the nature of the gains that are earned on an equity oriented mutual fund one has to first understand the nature of the gains that are being considered. The rise in the value of the fund as compared to the cost price of the fund is the capital gains that are earned on the fund. The time period for which the mutual fund has been held determines the nature of the capital gains. If the fund has been held for a period of less than one year then the gains are short term capital gains and if the holding period is one year or more then the gains become long term capital gains. The difference in the tax impact is that the short term capital gains is taxable at 15 per cent while the long term capital gains are taxable at zero per cent which means a savings of 15 per cent when one moves from one category to the other. 

Change impact 

One factor that should encourage individuals to shift their gains to the longer term is that unlike a normal equity share wherein there can be very sharp movements in the price in a short time period the same is usually not visible in terms of a mutual fund. For example a share can collapse 40 per cent in a matter of days in case there are some negative developments but a fund in case of a sharp downturn in the markets for a sustained time period will fall by around 10-12 per cent. Due to this reason there might not be a very big incentive to act immediately when there are some gains that are visible in the mutual fund. The idea for the investor is to ensure that they fall into the long term capital gains category and unless there has been a massive rally with a large crash inevitable there might not be an immediate reason to sell and try and lock in the gains. 

Stretching it out 

There is also the financial angle that the investor has to consider if they are deciding between holding on to the investments for some extra time and selling it off immediately to book the short term capital gains. One is the actual savings on the tax front which is going to be 15 per cent so this benefit is actually very clear. The other thing is that the shift to the longer term can also ensure that there is a longer perspective that is brought about on the investment and if the short term ups and downs are weathered out then the gains could be significant. Thus a holding could be converted into one where this is held for a period of several years and not just a year. This would provide the real benefit of equity oriented mutual funds and ensure that the gains are significant which is also a relief on the tax front.