Interactions with readers since Budget 2024 have made us realise that some investors are unaware of the difference between tax harvesting and portfolio rebalancing. One could also add “profit booking” into the mix. In this article, we explain the difference between these actions.
Profit Booking: This is a fallacy. You cannot redeem only profits from the capital markets. You buy at market price and sell at market price. So, any redemption will always have some part principal and some part capital gain.
The redeemed amount is pushed to fixed income instruments – savings account (where it waits for a “dip”) or FD or debt funds etc.
This is done with no specific portfolio management goal only because the profits “seem” high or the market overheated. Therefore, there is no way to assess the impact of this action. Most often, the primary benefit is the mental satisfaction of “quitting (in part) while ahead”.
Tax Harvesting: This is redeeming capital gains to the extent that they are tax-free (now Rs. 1.25 Lakhs) and reinvesting. The amount redeemed is reinvested in the same asset class immediately.
We will refer to this as tax-gain harvesting to differentiate it from tax-loss harvesting – offsetting capital gain with an allowed capital loss. See: How to use MF and stock losses to reduce your tax burden (tax-loss harvesting).
Tax gain harvesting lowers the overall capital gains outgo during redemption. To understand how this works, consider this simple, naive example.
- I buy 1 unit of an MF or a share for Rs. 20,000
- Assume the price after 10Y is Rs. 2,00,000
- Without tax gain harvesting, the taxable capital gain is Rs. 1.8L minus 1.25L (as per current rules) = 0.55L
- Suppose I redeem when the price hits Rs. 1.45L and re-buy again at Rs. 1.45L (this is only theoretically possible, but let us dream on)
- My CG of Rs. 1.25L is tax-free.
- My final CG is now Rs. 2L – Rs. 1.45L = 0.55L, which is tax-free.
- So, instead of paying tax on 0.55L, tax harvesting results in no tax.
When put like this, it sounds wonderful. However, the sequence of equity returns and portfolio size will significantly diminish gains. In our opinion, tax-harvesting is an unnecessary act with marginal gains. Over the long term, such gains will be comparable to a portfolio’s typical daily loss or gain due to normal market movements.
Portfolio rebalancing: This is done to rest the portfolio’s current asset allocation to the target asset allocation. Here, redemptions are made from one asset class (which is doing well) and reinvested in another.
This is done to reduce the volatility in the overall portfolio’s value and returns and keep them close to the target value and return. It is, therefore, an essential step regardless of tax and exit load rules.
See for example:
In summary, do not waste time booking profits or harvesting gains. Have a goal, decide on an asset allocation for that goal, plan to reduce risk systematically, and invest and rebalance as per that schedule.
Do share this article with your friends using the buttons below.
🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! ⇐ More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
Podcast: Let’s Get RICH With PATTU! Every single Indian CAN grow their wealth!
You can watch podcast episodes on the OfSpin Media Friends YouTube Channel.
🔥Now Watch Let’s Get Rich With Pattu தமிழில் (in Tamil)! 🔥
- Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
- Have a question? Subscribe to our newsletter using the form below.
- Hit ‘reply’ to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.
Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
About The Author
Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course! Increase your income by getting people to pay for your skills! ⇐ More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Most investor problems can be traced to a lack of informed decision-making. We made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, what would it be if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life? My answer: Sound Decision Making. So, in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parents plan for it, as well as teaching him several key ideas of decision-making and money management, is the narrative. What readers say!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. – Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications
You Can Be Rich Too with Goal-Based Investing
Published by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
This book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.
Your Ultimate Guide to Travel
This is an in-depth dive into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)
