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  • Rajan Bhardwaj

Indexation: What It Is, What It Does and How It Works In Mutual Funds

Indexation is critical in determining the gain or loss on your investment. Indexation decreases your overall tax obligation by adjusting the acquisition price of the underlying asset or investment. You will realise greater gains because you can adjust them for inflation at the time of selling. Let us have a look at every aspect in detail.

What Is Indexation?

Are you concerned that inflation will erode the returns on your investments? Is inflation taken into consideration when capital gains on the surrender of investments are calculated in accordance with tax laws? Put an end to your concerns and start indexing!

Indexation is a cost-effective method of protecting your investment profits from being drained by the government through taxes. Investments in long-term assets/funds such as debt funds and other investment types are eligible for indexation. Indexation aids you in modifying the buying price of your investments as the market fluctuates. Consequently, you will be able to reduce your tax liability as a result of this. First, you should comprehend two additional aspects: inflation and capital gains. Then you may start thinking about indexation.

Inflation is defined as a progressive increase in the price of a good or service over time. Consider the following example: a rupee worth Rs.100 currently may be valued Rs.110 or more the subsequent year, and much more in the coming years. Inflation has the effect of decreasing your purchasing power in this way.

That is, you will be able to purchase less items every year for the same amount of money as you can now, compared to what you can purchase today. Inflation will result in a rise in the price of a product or a service provided.

What is capital gains with respect to indexation of mutual funds?

Gains on investments are defined as an increase in an investment’s value over a specific period of time. If the net asset value (NAV) of a fund of your online mutual fund investment was Rs.10 last year and it is now Rs.15, the value of your investment has increased, and this is referred to as capital gain. When you redeem your investment, in this case, you would receive a capital gain of Rs.5 per unit.

The difference between the acquisition price of online mutual fund investment and the sale price of that investment is defined as a capital gain in this context. Capital gains are calculated in the case of debt funds that are long-term in nature (held for more than 36 months), after indexing the acquisition price of the investment. An experienced mutual funds distribution agency is competent to guide investors on every minuscule aspect of mutual fund investment.

Debt funds, in contrast to equity funds, are subject to long-term capital gains taxation at the lower rate of 20 per cent, with the advantage of indexation. It’s important to remember that indexation is not applicable to equities. Before planning Indexation, it is always wise to take assistance from a professional mutual fund agency.

What are the advantages of indexation, and how does it work?

Indexation is a term that refers to the process of modifying the invested value of an investment to reflect the effect of inflation over time. A higher purchase price results in lower profits, resulting in a lower tax burden.

Because of indexation, you get the leverage to reduce your long-term capital gains on your online mutual fund investment, which will result in a reduction in tax liability. When compared to standard fixed deposits, debt funds are considered to be a superior fixed-income investment alternative because of their indexation (FDs). Indexation transforms the game of investing into a win-win situation.

The Cost Inflation Index published by the government can be used to determine the rate of inflation to be utilised for indexation (CII). The index values are determined by the Central Government and are updated on the Income Tax Department’s website. You can see the Cost Inflation Index for the years 1981 to the present.

What is the indexation in Debt Funds?

Consider the following fictitious scenario: You made an online investment in a debt fund managed by a mutual fund in July 2016. You made a Rs.10,000 investment and purchased units at their Rs.10 net asset value (NAV). Three years later, in August 2019, you sell your assets at a net asset value (NAV) of Rs.20. When you redeemed your investments, they were worth Rs. 20,000. Your investment earned you Rs.10,000 in capital gains.

You would, however, be spared from paying tax on the first Rs.10,000. As a result of your three-year holding period, you will benefit from indexation, which lowers the long-term capital gain value.

To sum up:

Indexation makes debt mutual funds a viable investing strategy since it provides investors with the possibility to earn a healthy return, even after taking into account tax deductions. Using the cost of inflation index, indexation can assist in lowering one’s long-term capital gain, which in turn decreases one’s total tax liability.

As a result of the numerous advantages of indexation, such as the capacity to generate financial return, provide stability, and provide liquidity, index-linked assets are preferred over traditional fixed-income deposits.

If you are looking forward to Indexation in your mutual fund investment so that your profit remains unaffected from inflation, you can get in touch with Simplifysors.

It is the best Mutual fund distributor having a team of highly competent team that can manage your mutual fund portfolio.

Disclaimer: The above information is for education purposes only and does not compel any user to follow a set pattern. Before investing in any fund, it is advised to get in touch with the experts of Simplifysors.

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