The correct question to ask is “Does the Income I generate justify the amount of taxes I am paying?”

Because the bottom line is quite simple and straightforward – if we are going to have an income, we are going to have to pay taxes.

Our endeavor should be to pay Long Term Capital Gains (LTCG) tax as far as possible. That is because LTCG Tax is usually 10% or very close to that (after Indexation). This is usually the most Tax efficient income. Many other incomes such as salaries, profits, dividends, interest, etc. attract 30% or more in taxes, assuming you are in the higher tax bracket.

Some people hate taxes so much, they buy tax free bonds. They are happy earning 4-5% returns and not pay taxes rather than earn 10-15% returns and pay taxes on that, even though after paying taxes what they keep could have been double!!

It definitely is not necessary to hold off making changes that would benefit the portfolio, so as to postpone paying Long Term Capital Gains Tax, because we save nothing by postponing those taxes. These tax amounts will grow with time as the underlying investments themselves grow. On the contrary we certainly pay a price by not switching investments when there is a need to. It is useful to remember it as ‘not let the (tax) tail wag the (investment) dog’.

Several years ago, when Mutual Funds used to pay upfront commissions, unscrupulous intermediaries would make investors switch investments to generate more commissions for themselves. That is not true any more because Mutual Funds now follow an all-trail model. So it doesn’t provide any extra benefits to an intermediary for making an investor switch investments. SEBI registered advisors also typically charge a fee on the total assets and hence do not stand to benefit by getting the client to switch investments.

If we make the changes that the adviser asks us to make, we help her or him shoulder the responsibility she or he has, of looking after our portfolio and our financial life. When we avoid making the changes that matter because we are ‘worried’ about taxes, it disables our advisor from creating the outcomes that were mutually acceptable and desirable.

In summary, if most of the tax we are paying is by way of Long Term Capital Gains Tax, we are likely to be amongst the smartest wealth growers in the country.

- Devang Shah

December 1, 2021

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