Investment portfolios are subject to legal risks as the government. can make sudden changes
Investment portfolios are subject to legal risks as the government. can make sudden changes
The government can change rules and regulations or even create new laws. Some of these could come at an unexpected time. If such laws or regulations come into force, there is a chance that our investment strategy and existing portfolio will be adversely affected.
Some of these key measures that have impacted our financial, investing, and wealth-making habits include demonetization, extending the lifespan of long-term investments for debt funds from one year to three years, and eliminating the wealth tax, estate tax, the Land Ceiling Act, and of gold control law.
A friend’s daughter should have it tram (maiden performance of Bharatanatyam) a few days after the demonstration was announced. Because some of the musicians had insisted on cash payments, my friend and his family had to spend hours outside of banks and ATMs to get cash for the payments.
Again and again we have witnessed such legislation. In all of these situations, the harm or benefit to our portfolio came suddenly.
Sometimes such laws affect our investment portfolios directly, sometimes indirectly. For example, when the government decided to offer land for textile factories to build, the real estate market changed.
While this was a direct benefit, the indirect benefit was that an entirely new business district was created, jobs were created, and several other industries benefited.
On the other hand, when the capital gains structure of debt-based mutual funds changed, debt-based mutual funds suffered somewhat while bank fixed deposits (FDs) benefited.
Until a few years ago, we Indians had no way of dealing with legal risks, as these were often sudden steps. In addition, as investors, we had no say in the developments. However, the situation changed with the introduction of the Liberalized Remittance Scheme (LRS) in 2004. Under current regulations, a resident Indian can invest up to $2,50,000 per year outside of India. With the exception of a few countries, the funds can be invested in most parts of the world.
Investments can be made in any program regulated by the local government. However, this is also subject to change. And for a transitional period, this limit has been modified.
When we advise our clients to take advantage of the programs and invest a small portion outside of the country, most of the time their response is, “We get the best returns in India, so why invest outside of India?”
Always remember that risk and reward are two sides of the same coin. When we see good returns, there are also risks associated with it. If we only invest in India, all our eggs will be in one basket. Take a look at your portfolio – stocks, debt, gold, real estate and other investments are unique to India and are denominated in a single currency (INR). Any legislative development will affect all of these investments and we have no control over them. It is important to diversify investments to reduce portfolio risks.
Now in India we also have mutual fund schemes investing the body outside the country. These systems could also be considered to mitigate the risks.
Never make an investment that promises “supernormal returns” by exploiting loopholes in existing regulations, as the government could potentially plug them.
To avoid legal risk, diversify your investments across countries and avoid making money from loopholes in the system. Legislative risk is a systemic risk and cannot be avoided. Investors can only take action to reduce risk.
(The author is a financial planner and author of Yogic Wealth.)
