What are Indexation benefits?

Indexation is a process by which the cost of acquisition of an asset can be adjusted over a period of time in order to bring it to current prices after taking inflation into consideration. Indexation in mutual funds is a method of adjusting the cost of investment to account for inflation.

In this blog, we will discuss the benefits of indexation in mutual funds.

Indexation In Mutual Funds

Mutual fund investments generate Capital gains (Capital gain is a gain or profit realized by way of selling a property or other such asset/investment). These gains can either be Short Term or Long Term in nature, depending on the period for which these assets are held. Taxation is different for different types of mutual funds. However, the indexation benefit is available only for capital gains realized in Debt mutual funds.

A holding period of 36 months or more is considered long-term for Debt Funds. (For Equity mutual funds, long-term means a holding period of 12 months or more)

Indexation Benefit In Mutual Funds

The concept of Indexation makes investment in Debt mutual funds a lucrative proposition. Some of the notable benefits include:-

Lower Tax Liability: Indexation helps reduce the tax liability of the investor by adjusting the cost of investment for inflation. This leads to a lower taxable amount, reducing the overall tax burden on the investor.

Inflation-Adjusted Returns: By adjusting the cost of investment for inflation, indexation helps investors earn inflation-adjusted returns. This means that the returns generated from the investment are not eroded by the effects of inflation, and the investor's real purchasing power is maintained.

Improved Long-Term Performance: Over the long term, the effects of inflation can significantly impact the returns generated by an investment. Indexation helps mitigate this impact and leads to the improved long-term performance of the investment.

Increased Transparency: Indexation makes it easier for investors to understand the true performance of their investment. By adjusting for inflation, investors can better assess the returns generated by their investments and make informed investment decisions. Simplifies Investment Decision Making: By reducing the impact of inflation, indexation simplifies investment decision-making for investors. Investors can focus on other factors, such as the quality of the portfolio and the fund manager's track record when evaluating their investment options.

Conclusion

In conclusion, indexation offers several benefits to investors in mutual funds. It helps reduce tax liability, provides inflation-adjusted returns, leads to improved long-term performance, increases transparency, and simplifies investment decision-making. As a result, investors who choose indexation-based mutual funds are likely to benefit from better investment outcomes over the long term.