The author is the CEO of Psagot Mutual Funds. This does not include investment advice / marketing that takes into account the data and personal needs of each person and / or a substitute for the reader’s discretion.
Like the rest of the world, Israel is in an inflationary environment that will probably accompany us in the coming years. In an economic environment where the lives of all of us are becoming more expensive, there is room to calculate how to save on unnecessary expenses. One way is to take advantage of a basic and simple opportunity to pay less tax on investments at the same level of risk and potential similar return and thus improve our investment portfolio. In fact, the tax mechanisms on profits in the investment portfolio allow us to do so easily and especially in solid investments.
What are the two tax routes?
In Israel, there are two methods of collecting tax on profits in the capital market. The first, which is relevant to most investment channels and instruments, is the payment of 25% capital gains tax on real profit, meaning that in an inflationary period the profit will only be calculated if it is above the inflation rate. The second method is to pay a tax of 15% on the nominal profit, that is, without taking into account the erosion of the wind by inflation. This method is in fact relevant for investments in assets defined as “shekels”: bank deposits, makam, shekel government bonds or shekel corporate bonds.
If you put money in a deposit or in shekel bonds to maturity, you will certainly pay tax from the first shekel, even if in practice the price of money erodes following inflation. In other words, if you closed a bank deposit at a yield of 1%, only.
So how to invest in a shekel channel and pay only for the real profit?
The simplest way to take advantage of the distortion is to invest in exempt mutual funds that invest in shekel channels, ie funds whose entire assets are invested in shekel assets, and therefore are an alternative in the level of risk and the chance of direct holding in a shekel asset.
Because in mutual funds the tax exemption is in the real method, while an investor who bought a shekel corporate bond with a return of say 3% per year will pay a tax of 15% or almost half a percent each year on the coupons, whoever chooses to replace the investment in an index-tracking fund. Only in a short-term shekel bond at the same level of risk – will enjoy a tax shield. That is, even if the fund yields 3% just like the alternative in direct investment, the tax calculation will only be after deducting inflation. So if inflation is 3% or more, the investor will not pay capital gains tax at all.
Therefore, in a challenging economic environment it is important to take advantage of funds investing in shekel assets instead of direct holding of shekel bonds (state, corporate, makam, etc.).
Whoever replaces these holdings with similar products and invests through funds, is likely to enjoy a period of inflation from a tax shield that can sometimes be on the whole profit.