23 May 2016

Better Hybrid Funds

Hybrid funds fund some of their money in equity and some in debt. They are suitable for investors who don’t want to put all their money in equity. Or, for that matter, all in debt.

Importantly, hybrid funds have a tax advantage over making separate investments in equity and debt funds: if the hybrid fund invests at least 65% of its money in equity, it’s treated as an equity fund from the point of view of taxation, which means you pay less or no capital gains tax.

However, some hybrid funds invest most of their money in debt and only a little in equity, like 20%. These don’t have the tax benefit and should be gotten rid of. The mutual fund industry offers thousands of very similar funds, making it hard or impossible for investors to pick the right choice for them. So, get rid of hybrid funds that invest less than 65% in equity.

Also get rid of hybrid funds that invest more than 65% in equity. In other words, hybrid funds should invest exactly 65% of their money in equity.

That way, you can use a hybrid fund as part of your portfolio, knowing what you will get, and you can make other investments based on this knowledge.

For example, if you want to invest 80% of your money in equity, you can make two separate investments: 80% in a pure equity fund, and 20% in a pure debt fund. But this results in more tax on the debt fund. There’s a better option: if you have a hybrid fund that invests 65% of its money in equity, you can invest 57% of your money in the hybrid fund, and the remaining 43% in a pure equity fund. That way, you have the same asset allocation (80:20) but less tax. This works only if hybrid funds are more predictable.

In conclusion, all hybrid funds should invest exactly 65% of their money in equity. That would make them simpler and more predictable. And it will let you use hybrid funds as part of your portfolio, maintaining your desired asset allocation.

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