Effect of selling in a falling market and buying at a lower price:
Let's assume we have 500 units of an equity mutual fund (MF) scheme at a current NAV of Rs100 per unit that were purchased at an NAV of Rs70. Total purchase cost = Rs70*500 = Rs35,000
Now let's assume the market is falling and I am very tense. The NAV has fallen to Rs 90. I decide to sell all the units. Assume my holding is for less than a year, so short term capital gains (STCG) will be levied (@ 15%).
Exit load will be 1%.
What I get is
500 units* 90*99% = Rs44,550.
My gains will be (44550-35000)
= Rs 9550
My STCG will be 9550*15%= Rs1433
Nett of taxes and exit load what I have is 44550-1433 = Rs 43117
Now let's assume the NAV falls to Rs 80 and I invest all my proceeds into the same scheme at that NAV.
I get 43117 / 80 = 539 units.
Note that earlier I had 500 units.
Now let's assume that the NAV rises later to Rs115 and I again sell all the units at this NAV.
My redemption will now give me 539*115*0.99 = Rs 61365
My short term gains are now
61365 - 43117 = Rs 18248
My tax will be 15% * 18248 = Rs 2737
What I will have nett of tax is
61365 - 2737 = Rs 58628
If on the other hand I had never redeemed inbetween and I had held on the 500 units of the equity scheme and sold it at NAV of Rs 115 (and assume this happened after a year so it's long term capital gains).
My proceeds will be 500*115 =
Rs 57500. Note that there is no exit load because I sold after a year.
My gains = 57500 - 50000 = Rs7500
My tax will be max 10%= Rs 750
If my total long term capital gain across all instruments is less than Rs 1lac, I don't pay any tax. Else I pay 10% of the gains exceeding 1Lac.
So my tax in this case will be between zero and Rs750.
My nett will be between Rs 56750 and Rs 57500. And this is still less than Rs 58628 which I would have had if I had sold the scheme and repurchased and incurred TWO exit loads and TWO STCG @15%.
It may make sense to sell and repurchase at a much lower NAV. Note a lot depends on the difference between the NAV that I first redeemed and the NAV I repurchased at. If this spread was much less than Rs 10 (=90-80), this tactic wouldn't make sense.
What we have with this tactic is just a peace of mind that we have got out of a falling market. And if in fact we re-enter the market at a sufficiently lower NAV we stand to make a little extra money in the bargain. This is counter to the strategy of holding on for the long term.
Note also that the two STCG will result in tax cash outflow earlier.
Now let's make it a little more abstract.
Assuming that the first redemption was at NAV of x (=90)
And let's repeat the same calculations.
Proceeds from 1st sale
495x - (495x-35000)*.15
=420.75x+5250
New number of units
(420.75x+5250)/80
2nd redemption value
(420.75x+5250)/80*.99*115
=(420.75+5250)*1.423
=598.78x+7471
2nd STCG
(598.78x+7471)-(420.75x+5250)
=178.03x+2221
2nd STCG tax
=(178.03x+2221)*.15
=26.7x+333
Nett after 2nd redemption
=(598.78x+7471)-(26.7x+333)
= 572x+7138
Nett after LT redemption
= 500*115=57500
At what NAV are the two nett equal?
572x+7138=57500
X=88
So long as x> 88, double redemption gives more.
The question that remains is how is this value of x dependent on the other three NAV (70, 80 and 115).
Let's assume a, b, c are the three NAV, respectively.
Proceeds from 1st sale
495x - (495x-500*a)*.15
=420.75x+5250
=420.75x+75a
New number of units
(420.75x+5250)/b
=420.75x/b+75a/b
2nd redemption value before tax
(420.75x+5250)/80*.99*115
=(420.75+5250)*1.423
=598.78x+7471
=(420.75x/b+75a/b)*0.99*c
=416.5cx/b+74.25ac/b
2nd STCG
(598.78x+7471)-(420.75x+5250)
=178.03x+2221
=(416.5cx/b+74.25ac/b) -
(420.75x+75a)
=(416.5c/b-420.75)x+(74.25c/b-75)a
2nd STCG tax
=(178.03x+2221)*.15
=26.7x+333
=((416.5c/b-420.75)x+(74.25c/b-75)a)*.15
=(62.5c/b-63)x+(11.14c/b-11.25)a
Nett after 2nd redemption
=(598.78x+7471)-(26.7x+333)
= 572x+7138
416.5cx/b+74.25ac/b - ((62.5c/b-63)x+(11.14c/b-11.25)a)
=(354c/b+63)x+(63.11c/b+11.25)a
Nett after LT redemption
= 500*c=57500
At what NAV are the two nett equal?
572x+7138=57500
X=88
So long as x> 88, double redemption gives more.
(354c/b+63)x+(63.11c/b+11.25)a > 500c
X> (500c - (63.11c/b+11.25)a) / (354c/b+63)
(57500-7138) /571.9
=50362/571.9
=88
In the above equation, x is higher (desirable) as c/b becomes lower and as a is lower.
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