Retail investors must either use the systematic investment plan route or even if they are investing lumpsum, they should hold on to the units for 5-10-15 years and benefit from compounding.
Choose growth option that will help multiply money due to compounding
Mutual fund schemes that declare bonuses are a big draw, as these schemes allow investors to employ what is known in industry parlance as "bonus stripping" to book a short-term capital loss and set it off against long-term capital gains.
Let's assume an investor purchases a million units of an arbitrage scheme at a net asset value (NAV) of Rs 20. Let's say the scheme's NAV rises to Rs 21 three months later.
At the time of bonus, the investor will get 20 lakh units of Rs 10.5 each.
If the purchase is made more than 90 days before the bonus is declared, he can sell the original units and book a loss of Rs 9.5 per unit.
This loss can be set off against short- or long-term capital gains. Gains from sale of bonus units will not attract tax either, if sold nine months later.
The number of bonus plans, however, might decline considerably going forward, as Association of Mutual Funds of India (Amfi) has asked fund houses to stop accepting fresh subscriptions for bonus plans in their schemes.
Amfi also wants that no further bonus should be declared. While the current practice isn’t illegal, fund houses have been intimating investors about expected dividend or bonus payouts, which is against the spirit of regulation.
“It is a best practice circular and it's the moral obligation of all Amfi members to follow it in letter and spirit,” said Akshay Gupta, group executive head and CEO, Indiabulls Asset Management.
Manoj Nagpal, CEO, Outlook Asia Capital, believes that savvy investors might turn their attention to dividend stripping to reduce their tax incidence.
Dividend stripping is similar to bonus stripping, except that investors do not have to hold any units after the dividend is declared. However, the quantum of notional loss that can be declared through bonus stripping is much higher than that through dividend stripping, said experts.
Retail investors should not invest for bonus or dividend because in order to make money over the long term, they have to either use the systematic investment plan route or even if they are investing lumpsum, they have to hold on to the units for 5-10-15 years and benefit from compounding.
In recent times, some fund houses have come under attending for announcing bonus in their arbitrage funds.
In the past, they have raised significant amount of money as well through this strategy.
For a retail investor, the risks are that while the returns from arbitrage funds are not so high – around nine per cent annualised – if they are seen to be using the strategy too much or too often, the tax department get suspicious and label the investor a trader which can lead to higher taxes.
In the past, Amfi had tried to control bonus plans in 2003 through similar circulars, but several funds had ignored the directive back then.
Post 2003, even the IT department came out with stricter norms, stating that units had to be purchased three months before the record date to book a notional loss.
Bonus units had to be sold after three months, which was later extended to nine months.