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Regular readers of this column would know that we are an evangelist of long-term investing. Actually, the term 'long-term investing' in our dictionary is a euphemism for the combination of the powerful twin forces of compound interest and time. Compound interest in solitude means little. And time without the company of compound interest is equally meaningless. If you don't believe us, ask all those who have invested in endowment and money back insurance policies. In spite of holding the policy over a term of 15 and 20 years, since the bonus is not compounded, the total return remains poor.

That being said, our basic problem seems to be that inflation is where GDP growth should be and GDP is perhaps where inflation should be. The consequent impact on stock markets and mutual funds has been acute. Both stock prices and NAVs have come off over 30% (in some cases much more) from their all time highs.

But for a moment lets consider if things are really all that bad. As human beings, we tend to focus on the immediate past --- simply because it is the immediate past that is the freshest in memory. And since this immediate past (January 2008 onwards) hasn't been too kind on our investments, we have become consumed by self doubt and in some cases even panic.

This tendency of looking at the immediate past is also known as the near term perspective. A long-term investor would think a bit differently. While being fully aware of the recent happenings, he would also keep his eye on the big picture. While being mindful of the fact that NAVs have fallen by over 30%, he would also know that an SIP of Rs. 10,000 in a well managed diversified equity fund like say Reliance Growth over the past ten years would have grown to over Rs. 1 crore thereby earning a net tax-free return of 35% p.a.

However, this 35% p.a. hasn't been earned linearly every year like say your PPF would earn 8% every year. In the case of PPF, the initial investment of Rs.100 would become Rs. 108 in one year, Rs. 116.64 in the next year, Rs. 126 in the third year and so on. However, in the case of the Reliance fund, the return has not been earned linearly. In other words, in the fund Rs. 100 may not have grown to Rs. 135 in the first year, Rs. 182 in the second year and so on. Instead, the value (NAV) would have fallen or risen as per market sentiment, however, when you examine point to point, you would have earned a return of 35% p.a.

To further emphasize the benefit of long-term investing, let we share with the readers a very interesting piece of analysis that we came across in The Wise Investor, the monthly newsletter from Sundaram BNP Paribas Asset Management. Actually, this analysis is in the form of the accompanying chart. It shows the value of Re. 1 remaining invested at all times in the Sensex and what it would be worth if you missed the best days in the market. The numbers tell the tale. If you had stayed invested in the Sensex since launch, Re. 1 would be worth Rs 161. If you had missed the best ten days, the value would be Rs 62 and this number declines significantly to Rs 10 if you had missed the best 40 days.

(Source : The Wise Investor, Sundaram BNP Paribas Asset Management)

For a moment, consider the significance of this. The Sensex was launched in 1986. We are in 2008 today. That makes it roughly around 8,000 days since the launch of the Sensex. And of those 8,000 days, what makes the difference between a successful investor and an also ran is 40 days --- 40 days out of 8,000.

The key as we can see is to stay invested - for the simple reason that we do not know which would be the best days in the market. Of course, if you could sell only during the bad days and remain invested only during the good days, you would make more money. But that would mean predicting the future which is impossible. So the next logical thing to do would be to stay invested such that the good days are automatically taken care of. Or to put it differently, in the stock markets, patience is genius.

Question And Answer

Q : If my taxable income drops to near zero, can I start withdrawing from the NSS 1987 in amounts of Rs. 2.25 lakh per year, which is the tax free limit for senior citizens for FY 08-09? I have a total of Rs. 8 lakh accumulated in NSS 87. What remains after I pass away can be collected by my nominee or legatee.

--- C. Subbarao,

A : Yes, it would be an excellent policy to unlock the funds in NSS-87. As a matter of fact, if contribute Rs. 70,000 to PPF, mainly to earn the 8% tax-free interest rather than earn the deduction u/s 80C, you can withdraw as much as Rs. 2,95,000 (225000 + 70000) without coming in the tax net. You can withdraw Rs. 30,000 more by depositing this amount in other avenues u/s 80C. For instance, NSC pays 8% (tax-free in your case) whereas you are earning only 7.5% in NSS.

Q : I have a query about tax rate for short term capital gains and tax rate for total income. Say, I have a long term capital gains of Rs. 60,000 and short term capital gains of Rs. 3,00,000. I have no other income. Now what should be income tax I should pay? Should it be 10% of Rs. 3,00,000 i.e. Rs.30,000? Or should I use the slab rates as applicable to me? Please clarify how income tax should be calculated for this case.

--- J. Prabhu

A : The LTCG of Rs. 60,000 is tax-free. As regards short-term gains,

For a Resident individual or an HUF, where the total income as reduced by Short-Term or Long-Term Capital Gains on which tax is exigible falls below the tax threshold of Rs. 1,10,000 the gains would be reduced by the amount by which the total income so reduced falls short of Rs. 1,10,000 and the balance of the gains would be taxed at the rates applicable. In short, where the tax liability arises only because of inclusion of such capital gains in the total income, tax is levied on the excess over the minimum taxable limit. In your case, since you have no other income, you will have be liable to pay tax @ 10% on Rs. 1,90,000 (= Rs. 3,00,000-Rs. 1,10,000).

Please note that the 10% rate and Rs. 1.10 lakh limit is applicable only for FY 07-08. From FY 08-09, the rate of tax on short-term capital gains is 15% and the basic exemption limit is Rs. 1.50 lakh.

Q: I had availed for the purpose of construction of house in addition to an SBI loan, my employees co-operative society loan at fixed rate of interest. I want to claim deductions for these loans. The house is completed within three years from date of acquisition and it is used for self occupation. Is there any format for claiming the interest and principle for housing loan towards income tax.

--- M Kumar

A: The interest payable on capital borrowed for acquiring or constructing a self-occupied residential property is deductible with a ceiling of Rs. 1,50,000. The acquisition or construction should be completed within 3 years from the end of the year in which the capital was borrowed.

The assessee should obtain a certificate from the lender that such interest was payable on the amount advanced for acquisition or construction of the house, or as refinance of the principle amount outstanding under an earlier loan taken for such a purpose.

The authors may be contacted at wonderlandconsultants@yahoo.com