In turbulent times, to make tax savings and investments work for you, you need to adopt the approach where tax-saving is an investment first and a tax-saver later for many. The investment that should make most sense is in an equity-linked savings scheme (ELSS).
These are mutual fund schemes which invest a minimum 65 percent in equity and are notified to avail tax benefits under Section 80C up to Rs 1 lakh in a financial year. These mutual funds have a 3-year lock-in, which is the least among the available investment instruments that qualify for tax savings.
Investments up to Rs 1 lakh are eligible for deduction from your total income. i.e you can save up to 30,900 in taxes by investing 1 lakh in ELSS .The new direct tax code (DTC) provides for tax exemption of long-term capital gains from equity funds. Hence, gains from all investments made in ELSS even after DTC becomes effective will also be tax free.
The best way to invest in ELSS is through systematic investment plan (SIP). The best way is to spread your ELSS investment through the entire financial year - through 12 systematic investments which helps take advantage of fluctuations in the stock market.
Each SIP installments is treated as a separate investment and the installments must complete three years of holding for it to be redeemed. Redemption is on a first-in first-out basis since the units allotted first will be redeemed first.
Like any equity scheme, ELSS offers both dividend and growth options. The growth option is preferable for long-term wealth accumulation, as any incremental amount will get reinvested and compounded. Those in need of cash or pensioners can opt for the regular payouts or the dividend option.
Choosing an ELSS is fairly easy, similar to choosing a diversified mutual fund, but here's how NOT to choose an ELSS.
• Avoid funds that have less than three years of track record.
• Avoid funds that have an asset base of less than Rs.300 Crore. You can get this figure in the fund fact-sheet (available for download at the fund's site)
• Rank all ELSS in decreasing order of five -year returns. Choose one of the top three. we checked out ELSS performance during market crashes. There were two such crashes in the last five years.
• Many ELSS funds lost much more value than the indices both in 2008 and 2011. That is why anyone who made a lump sum investment in 2008 and didn't follow it up with the regular investment /SIP's you are definitely sitting on losses and this is what has happened to most of the investors,
This is the best guide you have - far better than agents peddling their vested interests and half-cooked analysis as 'Research'. Don't get just lured by the returns chart which you mutual distributor exhibits to you; as remember there's more to a mutual scheme than just returns. Look for the consistency in the performance instead, with relevance to risk and returns, portfolio turnover ratio expense ratio and the portfolio of ELSS mutual funds
The author is the CEO of Bombay Capital Services.
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