Equities are known to have given the best returns over the longer term. The Sensex has provided a return of 14-18 per cent over last 20 years on an average. Despite the availability of historical data, investors are still wary of equity investment. This is surprising considering investors pay a premium for their insurance for 20 years without making any fuss. If they can do the same in case of equity or a good equity oriented mutual fund, their returns will make them rich. Just to use the same example of the Sensex returns, an 18 per cent growth over 20 years means 27 times returns. This means if investors were invested Rs 1 lakh, 20 years back in the Sensex, the investment would have grown to Rs 27 lakh today.
Long-term and short-term
Investing for longer term requires patience because your investment may go down despite the company doing well in business. It also requires courage because you have to remain invested when everyone is leaving the market. In fact, you have to invest more and take advantage of a subdued market which enables prudent investors acquire sound stocks at an inexpensive valuation.
While long-term investment in equities does provide good returns, many of the investors are not equipped to deal with the patience and courage that long term investment demands. However, this is not a big problem. There are cases, where even short term investment can make you wealthy if you invest in sound stocks at cheaper price and maximise your gains using the stock market and taxation system.
In this article, we will see three of the ways to maximise your gains when you liquidate your equity investment. Remember, you only make money when you liquidate your investment. Why to just liquidate, let’s liquidate smartly.
Use tax policy
Long-term tax on equity is zero. This means if investors sold its holdings after one year, the tax liability to the investor will be zero. Hence, when you think of liquidating your investment within a year, think of taxation aspect for short term gain.
Compare the short term gain minus taxes with the long term gain which will happen if only you can wait for few months. If you see the short term gains despite taxes are higher because there is not much scope for price appreciation and dividends, you should go for short term liquidation. Otherwise, you can wait for the year to be over and liquidate. The profit is all yours.
Use short-term loss
Investors can also use the short-term capital losses against the short term gains to reduce the tax liability.
For example, suppose you made short term losses of Rs 1 lakh a year back. This year you made short term gain of Rs 1 lakh. You can subtract the loss of last year with the profit of this year and reduce your tax liability. If you have made short term gains in a year and you have few stocks in your portfolio that do not have much chance to appreciate in next few months, you can sell these stocks.
This loss can be used to set off the short term profit you have just earned to reduce the tax liability. When the tax year passes, investors can buy the same stocks at the same price or with slight variation.
Use bonus shares
Bonus shares help you book profit. Suppose you have 100 shares of Aurobindo Pharma at Rs 110 a share and you get a bonus share in 1:1 ratio. This means every shareholder will get one bonus share for every share he or she owns. Typically, when the bonus shares are announced, the price of shares in the market changes in the same proportion. Hence for the ratio of 1:1, the share price in the market should fall to half of the original price — Rs 55 a share.
Usually, this doesn’t work in a perfect way. The price stabilises at a point above the theoretical price. Suppose the new price of Aurobindo Pharma is Rs 60 a share. Now if the investor sells 100 shares of Aurobindo Pharma, the system will consider original 100 shares (First In, First Out method), which were bought at Rs 110 a share. The investor makes Rs 50 a share by this transaction on one share. Hence his total profit is Rs 5,000. Not only this, but he or she still has 100 shares which came as bonus.
— The writer is the CEO of bankbazaar.com