We all know the compounding benefit of investing in mutual funds. The longer you invest, the faster your money compounds. But there’s one more benefit that very few people understand.
Longer you stay invested in equity mutual funds – lower the long term capital gain tax you pay.
Let’s see how –
Example – Mr. A invests 1,00,000/- and he earns 15% annualised return on it. As per current law, he’s supposed to pay 10% LTCG tax (assuming he has already utilised the Rs. 1,00,000/- p.a. exemption limit.
As his investing time horizon increases to 20 years, the effective tax rate reduces from 10% to 3.77% !
Equity mutual funds enjoy the benefit of deferred taxation, that is, you don’t need to pay taxes on the amount earned unless you redeem your funds. Only in the year of redemption, you are supposed to pay taxes on your earnings. Essentially, the tax amount you’re supposed to pay each year is invested again and hence, you end up paying lesser amount on taxes in the year of redemption
This is the power of investing for a long period !
In the above example, Rs. 1,500/- (tax payable in the first year), actually stays invested (and is not paid as taxes to the government). And hence, the longer you stay invested, your net effective tax rate goes down.