Understanding tax risk is crucial for investors due to its significance in investment decisions.

Do you understand the significance of tax risk in investment?

The Covid-19 pandemic has shown how vulnerable Brazil’s public finances are to risks, highlighting the importance of fiscal policy in handling the economic consequences of such risks.

Brazil is dealing with a surge in public debt and the threat of an unmanageable fiscal situation, identified by analysts and investors as a key contributor to domestic uncertainty in the country.

Government spending to address the pandemic’s impact totaled R$ 587.5 billion, while tax incentives amounted to 8% of GDP, which is twice the average for emerging countries (3 to 4% of GDP).

The Covid-19 pandemic has worsened an already concerning situation, causing anxiety in the financial market regarding the potential increase in the fiscal deficit.

This article intends to explain the concept of tax risk and its significance for potential investors in 2021. Keep reading to learn more.

What does tax risk entail?

Tax risk refers to the chance of tax variables deviating in the short to medium term from what was expected in government budget or other fiscal predictions.

Tax risks, as defined by Tesouro Transparente, are events that could impact public finances and hinder achieving fiscal objectives, and cannot be controlled or prevented by the government.

The tax risk refers to the government’s vulnerability to fluctuations in overall revenue, spending, fiscal balance, and assets and debts within a short to medium timeframe.

Tax risks can be categorized as:

• General economic risks, like lower-than-anticipated economic growth leading to a decrease in government income.
• Potential expenses related to natural calamities are among the specific risks to consider.

Tax risks associated with contingent liabilities and other obligations like government guarantees can lead to significant fiscal instability if not managed properly.

Why is the tax risk a danger for investors in the financial market? Let’s find out.

What considerations should the investor remember regarding tax risks when investing in 2021?

The investor should carefully consider key information before starting to invest to avoid any unexpected outcomes. It is crucial to remember that one should assess the possibility of recovering their investment as the primary consideration.

The investor should assess if the return surpasses inflation and whether it will be higher or lower than the dollar when investing in another country. If the return is lower, there is a risk of financial loss.

The dollar’s fluctuation hinges on how the tax risk is perceived. It is crucial to assess whether this risk will cause the dollar to rise; if it does, investing may not be beneficial.

Discover whether investing in the dollar is a valuable venture by clicking here to read the complete article.

Examine the economic situation and the effects of international investors.

There was a significant outflow of foreign capital from the Brazilian Stock Exchange in the past two years, with B3 losing R$ 44.5 billion between January and September 2020, as reported by the Central Bank.

Selic interest rates

Understanding the cycle of Selic rate reductions is crucial. Despite predictions of Selic reaching a peak of 3.43% by year-end, the Copom highlights concerns about the nation’s tax risk.

The rise in public debt, worsened by the pandemic, leads to a slowdown in economic activities, prompting tax hikes and exacerbating the fiscal deficit.

When making an investment, consider the interest rate and think long-term to ensure that your investment will hold its value in “X” years.

Assess the potential tax implications and the effect on investments.

If fiscal risk arises, it can lead to the government not meeting its objectives, causing investors to demand additional assurances because of the uncertainty.

Investors became wary and many ceased investing in public bonds due to the absence of a proposal regarding funding for the Citizen Income, leading to a significant adverse effect, including on the Selic Treasury, a key component for building emergency reserves.

This economic situation led to losses for individuals who had already made investments, as the government now has to pay higher prices for the securities being sold.

Investments are influenced by future expectations, causing worry about the potential effects of fiscal risk on the Stock Exchange and other indicators.

The government is anticipated to achieve its targets, but if it fails to do so, it could lead to surpassing expenditure limits, resulting in a rise in public debt and interest payments.

The economic and political environment greatly impacts the investment landscape, highlighting the critical need for the government to implement robust risk management practices to safeguard the economy.

How to make investments in a situation involving tax risks?

How can one invest in a situation of fiscal risk, which affects the economic, political, and financial landscape?

Exposure to government risk can be controlled by assessing the risk features of assets and liabilities and creating portfolios that merge both.

There are two fundamental investment approaches to help mitigate and manage risks related to a particular investment or the overall market: asset allocation and diversification.

Asset allocation refers to the distribution of investments across different asset classes.

You can diversify your portfolio by including various types of assets (such as stocks, bonds, funds, CDI, and collective investments), which can enhance the likelihood of some investments gaining value, even if others remain stable or decrease in value.

Otherwise, you could decrease the chance of significant losses that might occur from overvaluing a particular asset class.

Variety or spreading out.

To succeed in investing, it is important to manage the balance between risk tolerance and investment time frame. Diversifying your assets across different classes is a key strategy to achieve this balance.

Diversification involves spreading the money allocated to a specific asset class across various investment categories within that class. This strategy helps in distributing investments effectively, thereby increasing returns and minimizing risks.

Having a variety of investments can help reduce risk by spreading out your assets. In other words, it’s not wise to put all your money into one investment.

Investments come with different levels and types of risks. It is important to evaluate these risks, understand their potential impact on your portfolio, and take steps to reduce them.

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