If the title of this article surprises you, we won't hold it against you. It's not common to find tax-planning being discussed this early in the financial year. Then again, good advice isn't commonly available either.
At Personalfn, we have consistently maintained that tax-planning is as much about contributing to your financial goals as it is about saving taxes. So, it shouldn't be treated as just another activity to be taken care of in a rushed manner, at the end of the financial year. Due thought and time must be accorded to tax-planning. Hence, the need to commence the process early in the financial year.
More specifically on tax-saving funds (also referred to as Equity Linked Savings Schemes -- ELSS), let's discuss what a tax-saving fund is and find out if it differs from a regular equity fund?
A tax-saving fund is an equity fund that enables the investor to claim tax benefits under Section 80C of the Income Tax Act; the amount invested is eligible for deduction from gross total income, subject to an upper limit of Rs 100,000 in a financial year.
Another distinguishing feature is that unlike conventional equity funds, investments in tax-saving funds are subject to a 3-yr lock-in. While most tend to frown at this provision, it should be welcomed. Investments in equities should be made over the long-term and the lock-in promotes the same.
Of course, being market-linked, tax-saving funds are high risk-high return investment propositions. Hence, you need to take into account your risk appetite before getting invested. This will help you determine what portion of your tax-planning portfolio (if at all) should be assigned to tax-saving funds. Typically, a risk-taking investor would hold a larger portion of his portfolio in market-linked avenues like tax-saving funds and vice-versa.
Now for the part about starting off with a systematic investment plan. An SIP can help you benefit from rupee cost averaging. Simply put, a staggered investment in a tax-saving fund (running over the financial year) is likely to be exposed to market ups and downs.
And by investing a fixed sum of money at regular time intervals, you stand to benefit from the downturns by way of higher number of units and a reduced average purchase cost. Also an SIP is lighter on the wallet as opposed to a lump sum investment. Hence, our view that now is as good a time as any to start off with an SIP in a tax-saving fund.
Having discussed the investment proposition offered by tax-saving funds, now let's discuss a strategy for selecting a tax-saving fund.
1. The fund house should pass muster
We believe that a fund house should make the grade before any of its funds can be considered for investment purpose. In other words, before considering a tax-saving fund, you must scrutinise the fund house on various parameters. For instance, the fund house must be strong on investment processes and philosophy.
It should pursue a process-driven investment style (as opposed to one led by a star fund manager). Then, the fund house should have an unblemished track record of having adhered to the investment mandates of its offerings at all times.
2. Opt for a flexible investment mandate
Avoid investing in tax-saving funds that have restrictive investment mandates. For instance, some tax-saving funds are positioned as mid and small cap offerings.
Such funds may find themselves in a rather unenviable situation, if the mid/small cap segment hits a rough patch and large cap stocks emerge as the season's flavour.
3. Seek diversification
It is not entirely uncommon to find a fund house's tax-saving fund, offering the same investment proposition as the flagship equity fund from the fund house. In other words, the only differentiating factors are the tax benefits and the 3-yr lock-in. For the sake of diversification, avoid duplication in your portfolio. Look for a tax-saving fund that has a character of its own, distinct from that of other funds in the portfolio.
4. Evaluate the fund's performance
Evaluate the fund's performance on the returns front over longer time frames (at least 3 years). Find out how the fund has fared vis-a-vis its benchmark index and peers. The fund's showing over prolonged downturns should be studied as the same is an indicator of its true mettle.
Of course, there's much more to a fund's performance than just returns. Its performance on risk parameters like volatility control and risk-adjusted return must also be studied. Then, the fund should have adhered to its stated investment mandate at all times.
Conclusion: If your risk appetite permits investing in a tax-saving fund, now is the time to scout for one and start off an SIP.
Your family's future depends on this. Read now.