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Tax Saving Mutual Funds

Benjamin Franklin, in the 17th century said, “In this world nothing can be said to be certain, except death and taxes”. This is something that is quite relevant even today. Most of our time in a year goes into tax planning. Taxes are an inevitable part of our life. However, we can smartly plan our investments in such a way so as to attract minimal taxes. The Government of India has made a provision for investors to save taxes under section 80C by investing in Equity Linked Savings Scheme (ELSS) or tax-saving Mutual Funds.

These mutual funds can help you to claim deduction on your taxable income, but they have a lock-in period of 3 years. It is evident by the name that the ELSS invests primarily in equities. Since, this is a pure equity-based fund, it is advisable to stay invested in it for a period longer than 3 years. This helps in negating the effects of volatility in the stock markets. You can invest in ELSS either in lumpsum or through the SIP mode with an amount as low as Rs 500.

Which investors are suitable for the ELSS?

When it comes to tax savings, people usually opt for conventional routes such as PPF, NSC, Life insurance etc. However, these being stable and less risky options are more suited to investors nearing retirement or those who are risk-averse. For young investors who have just started their careers and have a comparatively longer investment horizon, ELSS is a smarter option to save taxes. It gives them a chance to participate in the equity markets while also saving the taxes. These investments are higher on the risk element and require a long-term strategy.

Why should you invest in tax-saving Mutual Funds?

Inculcates disciplined investments: If you want to construct a good portfolio, it is necessary to have long-term investments. This is especially true for Mutual Funds. While most investors know that long-term investment is required in equity mutual funds, they are not bound by a certain period, such as in open-ended funds. However, ELSS being close-ended and having a lock-in period of 3 years discourages investors to exit the fund and reap full benefits.

Capital appreciation with tax-savings: This is one of the few tax saving vehicles wherein you can expect capital appreciation as well. Even though the lock-in period is 3 years, you can stay invested in it for longer and ride the growth wave. This will give you a chance to reap higher returns alongside tax exemptions.

Rewarding option as against other tax-saving instruments: As compared with other tax saving options, the ELSS has the shortest lock-in period of 3 years. A tax-saving fixed deposit, Employee Provident Fund (EPF) and NSC have a lock-in period of 5 years, while PPF has a lock-in period of 15 years. This way, the investor gets to see returns in a small-time frame of 3 years while saving the taxes. Not just this, the returns in other tax-saving options is capped between 6%-8%, while in ELSS the returns are linked to the market which has no upper limit.

Hassle-Free investment: The investment in tax saving mutual funds is hassle-free and happens at the click of a mouse. No filling up of elaborate forms, visiting banks or standing in queues. The SIP or lumpsum payment can be done online as well as offline with a very simplified and straightforward process.

What are the various options of investing in ELSS funds?

(1) Growth Options: In the Growth option of the ELSS, you will not reap any benefits in the form of dividends but the increase in the value of NAV over the period will be your gain. If you opt for the Growth option of ELSS, you will receive the amount at the end of the tenure. The only caution under the growth option is that it is totally linked to the market condition.

(2) Dividend option: As the name suggests, in this option you will receive dividends during the period and that too is tax-free. Many investors opt for dividend option in tax-saving Mutual Funds because there is no lock-in required for dividend declarations and they are eligible to receive a part of their investment even before the completion of the tenure.

(3) Dividend Re-investment plan: This is a sort of option that offers the best of both worlds. The dividend received by you can be added to the NAV if you so decide. This way you receive periodic payments which will also help you to build the capital.

How should you select the right tax saving mutual Fund?

ELSS is full of features that are beneficial to investors in the long-run. However, it is important that you choose the right fund for yourself amongst the many options available in the market.

(1) Analyse the risk-adjusted returns of the funds in the past: You should always view the returns in relation to the risk. Information ratio is an important indicator of risk-adjusted returns. Information ratio judges the portfolio’s performance against the standard deviation of the returns. Standard deviation shows the deviation of the returns from the benchmark index and this is the real test of the Fund Manager.

(2) Consistency of returns: The returns of mutual funds over the past few years, say a minimum of 3-5 years needs to be consistent. If a tax saving mutual fund performs very well in 1-2 years or but doesn’t maintain the same in the next few years, it is not worthwhile investing in the fund. Furthermore, the returns of the fund over the past 5 years needs to be compared with the returns of the other funds in the same category as well as the benchmark. To judge the returns over the past 5 years, you must look at the Information ratio as well as the CAGR of the fund.

(3) Diversified ELSS in portfolio: There can be diversification in the portfolio of ELSS as well. Your portfolio can consist of 2-3 best performing ELSS and enjoy the benefits of diversification. You can also choose to opt for the Dividend plan in some funds and the Growth option in some plans.

(4) Expense ratio: Expense Ratio helps you to determine how much returns will you take home as an investor after paying for the fund management expenses. A lower expense ratio means more take-home returns and vice versa. Therefore, it is prudent to choose a fund that delivers consistent good returns with a low expense ratio.

(5) Other parameters: There are other parameters for choosing the right tax saving Mutual Fund. Important performance ratios such as Sharpe’s ratio, Treynor’s ratio, Sortino’s ratio and measures such as Alpha and Beta say a lot about the riskiness of the portfolio. As an investor, the fund chosen should be in line with your risk appetite. A fund with a greater standard deviation or beta indicates a higher risk element which should be avoided if you aren’t willing to take risks.

Top performing ELSS Funds:

1. Reliance Tax Saver Fund:

This is a tax-saver fund from the house of Reliance. The funds have given a return of 20.26% over the last 5-years. The asset of the fund at Rs 9,630 crore is much lesser than that of AXIS long term and DSP BlackRock.

2. Axis Long Term Equity Fund:

Along with tax savings, Axis Long term fund is one of the best choices for those who are looking at capital appreciation. The Funds have generated a 5-year return of 22%. Most of the investments is in the technology and financial sector.

3. DSP BlackRock Tax Saver Fund:

This fund aims at medium to long-term capital appreciation. This portfolio is diversified and invests in equity and equity-related securities of the corporate. The 5-year return of the fund is 19.18%. This is an open-ended scheme with investments mainly in the Banking & Finance and Technology sector.

4. Aditya Birla Sun Life Tax Relief ’96:

This scheme aims at long-term capital growth and invests 80% of the funds in equities. Even though it is a tax saver fund, it has been converted to an open-ended scheme from 1999. The asset base of this fund is about Rs 6534.27 crores. The 5-year return for Aditya Birla Sun Life Tax Relief 96 is 21.19%.

5. Franklin India Taxshield Fund:

The asset under management for Franklin India Taxshield fund is around Rs 3,600 crores and the 5-year return of the fund is 18.25%. This fund mainly invests in equities with a part of investment in PSU Bonds, debentures and Money Market instruments. The major investment of the fund is in the financial sector and part investments in automobile and technology as well.

Frequently asked Questions

1. How can I save taxes through ELSS?

The Government of India has mandated that you can save taxes by investing in Equity Linked Savings Scheme (ELSS) or tax-saving Mutual Funds. The maximum tax deduction is to the extent of Rs 1,50,000 per annum.

2. What are the various options of investment in ELSS?

You can invest in ELSS and opt for Growth Plan, Dividend Plan and Dividend Re-investment plans. But since dividend received is taxable, most investors opt for growth plans.

3. What are the advantages of investing in ELSS as compared to other tax-saving instruments?

There is no maximum limit in investment or a long-term lock in period. The returns in tax saving Mutual Funds also have no upper limit and neither are they taxable.

4. Which investors can opt for ELSS?

The investors who want capital appreciation and exposure to markets while saving taxes can opt for ELSS.

5. What factors should I choose before investing in ELSS?

You should check the risk-adjusted historical returns of the fund, its consistency of returns, the expense ratio and its performance as compared to other funds.

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