scorecardresearchYour Questions Answered: I want to buy ₹20 lakh car after 2 years. How

Your Questions Answered: I want to buy 20 lakh car after 2 years. How much should I invest in the mutual funds now?

Updated: 22 Mar 2023, 08:54 AM IST

To reach your short-term goal of purchasing a car worth 20 lakhs in 2025, you should invest in debt mutual funds with a modified duration of less than 5 years, or hybrid-equity savings plan with expected pre-tax returns of 5-6% taxed at 15% for short-term gains.

The higher the volatility in the stock markets, the is the opportunity to lock higher returns.

The higher the volatility in the stock markets, the is the opportunity to lock higher returns.

Q. I am 34. I am planning to purchase a car worth 20 lakhs by 2025. I have identified three mutual funds: direct plan, growth schemes (Bank of India Multicap; Nippon India Nifty G-sec Oct 2028; and SBI Dividend Yield Fund). Have I chosen right? How much should I invest in each? 

It's good to see that your objective is specific, measurable and time-bound. As your requirement is short-term, you must invest in a stable asset class that will provide predictable returns. If we assume a growth rate of 7% after tax, you need to invest about 34,000 per month to build the funds you need in two years. 

The equity asset class is only appropriate for investments with a medium- to the long-term horizon (3 years or more). It may not be ideal to park money in the Bank of India or the SBI funds you have specified, because these asset classes are susceptible to market volatility. The Nippon India fund you have chosen is a targeted maturity fund. It may not meet your requirements after two years.

Consider two alternatives. 

Debt mutual funds

 These offer stable and predictable returns. Debt mutual funds invest across different tenures. Since your goal must be accomplished in two years, you should focus on categories like money market, low duration, and short duration. 

Before investing in debt mutual funds, it is crucial to educate yourself on certain terms. 

"Modified duration" refers to the metric that helps in determining the expected change in the value of a security as interest rates change. In other words, modified duration measures a bond's sensitivity to interest rate changes. 

The quality of the underlying portfolio paper should be rated AAA or Sovereign with a lower expense ratio. The expense ratio is the annual fee that fund investors pay to cover the operating costs of running the fund. It is expressed as a percentage of the fund's assets and is deducted from the fund's net asset value. This can have a significant impact on the fund's performance and overall returns.

The expected returns that you can take into consideration are the yield to maturity (YTM) of a fund minus the expense ratio. YTM represents the total return expected on a bond if the bond is held until maturity.

Short-term capital gains from debt funds (held for less than 36 months) are taxed according to each taxpayer's tax bracket. Your short-term capital gains from a debt fund will be taxed at 30% if you pay tax at that rate, which could affect your overall net returns.

Hybrid-equity savings

The second choice you might think about is a combination of equity savings plans—hybrid-equity savings. These could include arbitrage funds, and debt mutual funds as they incur lower investment risk. Equity savings have greater exposure to debt and less exposure to a mix of equity and debt assets.

The expected pre-tax returns will be around 7% to 8%, taxed at the equity asset class rate (10% after a one-year holding period). If you hold the investment for less than 12 months, then capital gains will be considered as short-term and taxed at 15%. 

On the other hand, an arbitrage fund seeks to generate pre-tax returns (5% to 6%) through price differences in different capital market segments. The fund manager creates a market neutral position by buying in the cash market and simultaneously selling the same security in the futures market.

The higher the volatility in the stock markets, the is the opportunity to lock higher returns. The taxation here is as in the case of the equity savings plan. 

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First Published: 22 Mar 2023, 08:54 AM IST