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Are you booking profits for yourself or for your distributor?

This article was posted on Aug 12, 2007 and is filed under Press Releases

Long term investment in equity is considered a safe way to cut risks and make good returns.

But sources indicate the average holding period of equity mutual funds is about 4 to 9 months.

Why pay 10% capital gains for the short term (less than one year), when long term gains are tax free?  

Maybe you are thinking, “If I can make 10% returns every few months, why not book profits?”

 Let us assume individual A makes a 10% profit (returns of 30% per year) every four months.  Individual B, a long-term investor, does thorough research in selecting his advisor, even questions his recommendations. Only then does he invest. He intends to hold on to his investments for the next three years. His returns expectations are a modest 20% pa. 

Here’s how A actually performed:

Invested Amount Entry Load Net invested Return Amt with gain Short term cap gains Net amt

This goes to show that if B made gains of 21% per annum, he would be better off than A. Here, a couple of factors need to be highlighted.  

1. There is no guarantee that the aggressive distributor will get you profits of 10% each time. He could err on the timing of the purchase, the sale, or even both.

2. More important, the only person to make profits in the aggressive investor model will be the distributor!

Notice the entry load paid by the investor in the former case, ie 7.2%? Most of this is the distributor’s earnings. So at the end of one year, in the above example, A and B made almost identical returns. But have a look at the table below: 

Returns Income Tax paid Distributor earnings
Investor A 21.0% 3.1% 7.2%
Investor B 20.0% 0.0% 2.2%

I rest my case against churning, or what is popularly called ‘profit booking’. That term apparently is for distributors and does not include you, the insignificant investor. 

Money Matters Mantras

Equity investment is for the long-term
Switching in and out of schemes may be justified if done for the right reasons (like change of fund manager, underperformance of scheme in the long-term).
Ask questions when your distributor recommends profit booking too often.
Question your distributor whether he can get exit calls right each time, time after time: if he can, is he caught in the wrong profession? (He ought to be the fund manager)

 

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