Death and taxes, they say, are unavoidable. While there is nothing really you can do about the first, tax saving instruments can relieve some of the pain caused by the latter.
While tax-saving instruments like Employees Provident Fund, Public Provident Fund and National Savings Certificate have been there for a long time, Equity Linked Savings Schemes are now offering investors a way to look beyond the world of low returns. These are mutual funds that invest in stocks and offer a tax benefit under Section 80C.
Though ELSS -- also known as tax planning funds -- have been available for more than a decade, Budget 2005 changed the dynamics of the ELSS universe. The hike in investment limit in ELSS changed from a mere Rs 10,000 to Rs 1,00,000 and threw open the possibility of building wealth through tax planning.
ELSS are in the middle of a dream run. Even an average fund of this category has outperformed the Sensex in the last four successive calendar years.
In the three year period ended April 7, 2006, Magnum Taxgain delivered an annualised return of 107%, which is by far the best of any diversified equity fund or tax planning fund.
Last year, an average tax planning fund gave a return of 51.66% while the Sensex only rose by 42.33%. This time Magnum Taxgain rose by 96.06%. The second best -- HDFC Taxsaver -- was way behind with a return of 74.84%.
Of the 23 tax saving funds, 14 have outperformed the Sensex this year from January 1 to April 7.
You simply cannot ignore tax planning funds.
Consider this: Rs 1,00,000 (which is the limit under Section 80C) invested even in the worst tax-planning fund in the past five years through the Systematic Investment Planning route (which requires fixed amounts every single month) would have built a corpus of over Rs 12 lakh (1.2 million). Had you invested in the best fund during the period, you would have been sitting on a cool Rs 27.51 lakh (Rs 2.7 million)!
This is a huge amount if you consider the returns of your other tax-planning investments.
ELSS can be volatile...
In 2002, there were few mid-cap oriented portfolios and nearly 80% of the funds had portfolios dominated by large-cap stocks. Things changed from 2003 onwards when mid- and small-cap stocks started to blossom.
As things stand today, only a quarter of the tax-planning funds have large-cap dominated portfolios.
While this has meant good returns for the investors, they are forced to negotiate with higher volatility and low-quality portfolios.
With the markets being so volatile and scaling new heights, fund managers are playing it safe and making an effort to diversify their risk by bringing in more stocks into their portfolios.
For instance, in March last year, funds had invested in only 261 individual stocks. Today, that number has increased to 428.
So, dear reader, don't wait for March to save taxes. Instead draw up a plan right away.
The money coming into ELSS indicates that the bulk of the money is being invested in March. This is the worst possible way to invest in an equity fund. You should spread your out investment over a year for tax saving purposes.
Pick a tax saving mutual fund to invest in and start a Systematic Investment Plan, where you put in fixed amounts every month. But choose your fund carefully. Any mistake here could prove expensive because your money has to be locked in for three years.
To help you choose the right fund, we have picked up the five best in the category and will be writing about them tomorrow.