Personal Finance

Don’t forget to keep track of losses

ARchit Gupta | Updated on November 18, 2018 Published on November 18, 2018

In a bear market, many get into panic mode. Follow a few strategies to cut down losses

In the latest Budget, the Centre changed the law to make long-term capital gains (LTCG) from the sale of equity fund units, taxable. Tax must be paid at the rate of 10 per cent on gains in excess of ₹1 lakh. However, investors may incur losses, too, upon selling units of equity funds.

Earlier, since gains were tax-exempt, loss was also considered a dead loss and was of no use in tax computations. Now, investors can set off long-term capital losses against LTCG from units of equity funds which are sold after March 31, 2018.

Loss incurred on sale of equity fund units within a year from the date of allotment is called short-term capital loss (STCL). When the loss occurs after a year from the date of allotment, it is called long-term capital loss (LTCL).

Long-term losses incurred on sale of equity fund units between February 1, 2018, and March 31, 2018, cannot be set off against capital gains. Beginning April 1, 2018, you may set off LTCL against LTCG and also carry forward the unabsorbed losses for setting off in future for eight assessment years.

Suppose a taxpayer makes LTCG worth ₹10 lakh on sale of units of equity fund A. In the same year, she suffers LTCL of ₹5 lakh on sale of units of equity fund B.

In this situation, she can set off the LTCL of ₹5 lakh against the LTCG of ₹10 lakh. After setting off and availing herself the exemption of ₹1 lakh, her taxable gains will be ₹4 lakh. It is for this reason that you must keep track of your capital losses — to systematically reduce tax liability.

However, you need to keep in mind certain things while setting off capital losses. LTCL can be set off only against LTCG. But STCL can be set off against both LTCG and STCG.

In a bear market, many investors get into panic mode. But each bull phase will be followed by a bear phase, and so on. So, you may need to follow a few strategies to cut down your losses.

Staying put

The moment an investor comes across a bear phase, the most common reaction is to pull out.

In an impulse, investors fall into the trap of ‘buy high, sell low’, locking in big losses and avoiding huge gains. Instead, make a calculated move and stay put.

Rebalancing

In a bear market, rebalancing comes handy. Rebalancing is a way of bringing your current asset allocation back to your original allocation. Suppose you started investing with an equity-debt ratio of 60:40 and the market slump has skewed your allocations to 30:70. On the face, your portfolio risk has reduced for the time being because it has become debt-oriented. However, if you don’t rebalance, you might lose on the future gains that equities may bring in when the markets recover.

Don’t over-diversify

Many have the habit of investing into too many funds in the name of diversification. Diversification, in itself, is an effective strategy to spread firm-related (unsystematic) risks.

However, excessive diversification may cancel out the advantages in varied ways.

Firstly, you may end up investing in funds that have similar stockholdings.

This will negate the positive effects of diversification.

Secondly, it will become difficult to keep track of multiple funds in a portfolio. Hence, it is better to stick to, say, 7-9 funds that are aligned to your overall goals.

Don’t catch a falling knife

A good fund is one which is able to curtail losses during bear markets. Fund performance may go down during a bearish phase. However, if you spot funds that have remained consistent bad performers during market slumps, those may be red flags. If you find that the fundamentals are poor, and the bad performance is due to a firm-related event, don’t stick to the fund.

No one-sided decisions

A bear phase may cause investors to develop biased behaviours. Confirmation bias is when investors accept only the news which match their assumptions.

If they come across any negative news about the funds they hold; they tend to ignore it owing to false conviction.

To keep losses at bay, it is necessary to place decisions on facts and figures rather than gut feeling.

The writer is founder and CEO, ClearTax

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