AT A time when most people are getting impacted by rising inflation and poor returns on their investments, tax planning assumes great importance. Most people look for avenues that would help them not only evade the claws of tax collectors but also save on money. Among the many options available, most financial experts recommend investment in tax-saving funds, tempting you to put all your money into this scheme. But before you take the plunge, here’s what you need to look into before investing in a tax-saving fund.
TAX BENEFITS
While the primary benefit of a tax-saving fund is implicit in its name, tax benefits are dependent on the investment made in the fund. According to Section 80C of the investment tax law, all investments up to Rs 1 lakh are exempt from tax. In addition, tax-saving schemes offer tax rebate under Section 88 up to a maximum of Rs 10,000. Also, since the lock-in period for tax saving funds exceeds one year, you can be guaranteed of exemptions from long-term capital gains tax.
INVEST INTELLIGENTLY
While you may wish to avail of the maximum tax benefits possible, financial experts say you need to invest your money intelligently. Since tax-saving mutual funds are generally close ended funds with a lock-in period of three years, it is better to invest only as much money as you know you will not require in the next three years. This will protect you from liquidity crunches. After three years, when earlier investments will have liquidity, investors can invest in a tax planning fund to the extent of the tax exemption bandwidth of the investors i.e. 1 lakh,.
LOOK BEYOND
Investors generally make up their mind based on the previous performance of the fund. But remember, while a fund may be doing good over the last week or the last month, you need to analyse its performance over a longer period. The ideal position would be to compare the performance of the fund over a period of three years or about five years. This should give you a clear indication of whether a fund has stood strong even when the markets have faced a bull run or a bearish phase.
ABOVE THE MARKETS
Returns play a pivotal role in determining which fund you choose. However, when you approach your financial experts, they may refrain from making predictions, saying that returns are entirely dependent on market dynamics, macro economic developments, regulatory changes and so on. But the simple and most effective way would be to check whether your fund has outperformed the benchmark in terms of returns over a three-five-year horizon and by how much. You could use this while making the choice between funds, which have similar investment approaches.
MARKET CAPITALISATION
Market capitalisation, which means exposure to mid, small and large cap stocks, is another important aspect to be considered based on the investors risk appetite. You need to evaluate whether your fund has a well-balanced approach and is investing both in companies, which have a good record, and also in those which are exhibiting a good growth potential.
KNOW THE NUMBERS
It is quite possible that in the process of evaluating the performance of a fund, your financial experts quotes a few ratios that don’t really make any sense to you. For your convenience, here are the explanations of a few of these numbers.
The risk-adjusted return is a good indicator of the performance of a particular fund and this is further indicated by the information ratio. To get the information ratio, subtract the benchmark return from the portfolio return, and divide it by the standard deviation of the portfolio return. This measures the portfolio manager’s ability to deliver excess return over the benchmark for every unit of risk taken.
This is another indicator of risk-adjusted performance. It is generally defined as the excess return per unit of risk that the portfolio carries. It shows how an investor is rewarded (in terms of returns) for each unit of risk that he/she takes. However, for the purpose of evaluation, the higher the Sharpe ratio, the better is the fund.
This is a statistical calculation that measures the volatility of returns and hence indicates risk. A large dispersion tells us how much the return on the fund is deviating from the expected normal returns. The higher the standard deviation, the higher is the risk.
It indicates the maximum expenses that would be charged to the scheme towards administration of the fund, fund management fees, expenses of sending account statements to the investors and so on. This takes away from the NAC of the scheme. So the lower the expense ratio, the better it is for the scheme.
ADDED BENEFITS
While a tax-saving fund has a three-year lock in period, the advantage is that it begins from the day the money is invested and not on the financial year. Moreover, dividends distributed and the units credited in the event of a bonus declaration are not covered by the lock in clause. There is also a great deal of transparency with regard to the operations. An ELSS scheme also offers the advantage of convenience whereby investors can utilise investment tools like a systematic investment plan that will help mitigate the volatility risks and maximise return potential through the advantage of rupee cost averaging.
TAX BENEFITS
While the primary benefit of a tax-saving fund is implicit in its name, tax benefits are dependent on the investment made in the fund. According to Section 80C of the investment tax law, all investments up to Rs 1 lakh are exempt from tax. In addition, tax-saving schemes offer tax rebate under Section 88 up to a maximum of Rs 10,000. Also, since the lock-in period for tax saving funds exceeds one year, you can be guaranteed of exemptions from long-term capital gains tax.
INVEST INTELLIGENTLY
While you may wish to avail of the maximum tax benefits possible, financial experts say you need to invest your money intelligently. Since tax-saving mutual funds are generally close ended funds with a lock-in period of three years, it is better to invest only as much money as you know you will not require in the next three years. This will protect you from liquidity crunches. After three years, when earlier investments will have liquidity, investors can invest in a tax planning fund to the extent of the tax exemption bandwidth of the investors i.e. 1 lakh,.
LOOK BEYOND
Investors generally make up their mind based on the previous performance of the fund. But remember, while a fund may be doing good over the last week or the last month, you need to analyse its performance over a longer period. The ideal position would be to compare the performance of the fund over a period of three years or about five years. This should give you a clear indication of whether a fund has stood strong even when the markets have faced a bull run or a bearish phase.
ABOVE THE MARKETS
Returns play a pivotal role in determining which fund you choose. However, when you approach your financial experts, they may refrain from making predictions, saying that returns are entirely dependent on market dynamics, macro economic developments, regulatory changes and so on. But the simple and most effective way would be to check whether your fund has outperformed the benchmark in terms of returns over a three-five-year horizon and by how much. You could use this while making the choice between funds, which have similar investment approaches.
MARKET CAPITALISATION
Market capitalisation, which means exposure to mid, small and large cap stocks, is another important aspect to be considered based on the investors risk appetite. You need to evaluate whether your fund has a well-balanced approach and is investing both in companies, which have a good record, and also in those which are exhibiting a good growth potential.
KNOW THE NUMBERS
It is quite possible that in the process of evaluating the performance of a fund, your financial experts quotes a few ratios that don’t really make any sense to you. For your convenience, here are the explanations of a few of these numbers.
- INFORMATION RATIO
The risk-adjusted return is a good indicator of the performance of a particular fund and this is further indicated by the information ratio. To get the information ratio, subtract the benchmark return from the portfolio return, and divide it by the standard deviation of the portfolio return. This measures the portfolio manager’s ability to deliver excess return over the benchmark for every unit of risk taken.
- SHARPE RATIO
This is another indicator of risk-adjusted performance. It is generally defined as the excess return per unit of risk that the portfolio carries. It shows how an investor is rewarded (in terms of returns) for each unit of risk that he/she takes. However, for the purpose of evaluation, the higher the Sharpe ratio, the better is the fund.
- STANDARD DEVIATION
This is a statistical calculation that measures the volatility of returns and hence indicates risk. A large dispersion tells us how much the return on the fund is deviating from the expected normal returns. The higher the standard deviation, the higher is the risk.
- Expense ratio
It indicates the maximum expenses that would be charged to the scheme towards administration of the fund, fund management fees, expenses of sending account statements to the investors and so on. This takes away from the NAC of the scheme. So the lower the expense ratio, the better it is for the scheme.
ADDED BENEFITS
While a tax-saving fund has a three-year lock in period, the advantage is that it begins from the day the money is invested and not on the financial year. Moreover, dividends distributed and the units credited in the event of a bonus declaration are not covered by the lock in clause. There is also a great deal of transparency with regard to the operations. An ELSS scheme also offers the advantage of convenience whereby investors can utilise investment tools like a systematic investment plan that will help mitigate the volatility risks and maximise return potential through the advantage of rupee cost averaging.
