Tax Saving Mutual Fund – ELSS

Saving tax through Mutual Fund? While the traditional options of Life Insurance, National Saving Certificates (NSC) and Public Provident Fund (PPF) are on top of the mind when one thinks of investments directed at saving taxes, it would be worthwhile to take a look at some mutual funds that offer tax benefits under Section 80C. One such type of mutual fund scheme is called Equity Linked Saving Schemes or ELSS.

Saving tax through Mutual Fund? While the traditional options of Life Insurance, National Saving Certificates (NSC) and Public Provident Fund (PPF) are on top of the mind when one thinks of investments directed at saving taxes, it would be worthwhile to take a look at some mutual funds that offer tax benefits under Section 80C. One such type of mutual fund scheme is called Equity Linked Saving Schemes or ELSS.

Equity Linked Savings Schemes (ELSS) – An Introduction

Equity Linked Savings Schemes or ELSS are the most popular tax saving option in mutual funds, these schemes carry a lock in period of three years. Regulation stipulates that these schemes invest at least 80 per cent of their assets in equity and related securities. Moreover, the Income Tax Act specifies that tax benefit on ELSS can be provided under section 80C and would be a part of the combined investment limit of Rs.100,000 available under this section.

Most mutual fund houses have an open-ended ELSS, some with very specifically defined investment objectives. It is important to understand that investment in such schemes is surely riskier than investment in NSC or PPF. The chances of a heavy upside in case of a stock market boom exists, however you also run the risk of principal erosion in case the tide in market reverses.

Why to invest in Mutual Funds in such volatile markets?

The poor performance of stock markets in 2008 has negatively impacted investor sentiments leading to investments in equity mutual funds virtually coming to a halt. As per the Association of Mutual Funds in India (AMFI) data, net investment in equity funds  during the financial year 2008-09 came down to just Rs 2,673 crore as compared to a Rs 24,150 crore over the same period a year ago.

Warren Buffet’s golden rule of investing states “Be fearful when others are greedy & greedy when others are fearful”. However, historic data and facts shows that the retail investors always go against this rule. The enter into equity and equity linked investments when the Markets have already heated up and shy away from these investments when the market have fallen significantly. The decline of around 89 per cent in Equity Mutual Funds just proves this point.

Now that markets have started to look up, it makes sense to start investing in Mutual Funds. For starters, what could be better than investing in an Equity Linked Saving Schemes (ELSS) that offers tax saving as well as potential for generating higher returns!

ELSS : How to invest in volatile markets?

If you want to wait for the right moment to start investing in ELSS or for that matter any mutual fund scheme, believe it or not, you may never be able to start. Markets may swing in either direction, which no one can predict. This makes timing the market a very difficult task for a retail investor. Like any tax saving investment, ELSS too has a lock-in period (3 years for ELSS investments). So even if the market swing either ways in the short to medium term. On a 3-year horizon they have a potential to generate better returns than any other asset class.

Coming to the point on how to invest? Well, as a retail investor Systematic Investment Plan is the best way to invest.

Which ELSS to choose?

This is a million dollar question. Unlike other open-ended mutual fund schemes ELSS carry a lock-in period which helps reduce redemption pressure for the first three years of investment. Fund Manager can therefore allocate ELSS asset under management for a longer term investment.

The simple most effective method to choose ELSS is to check the performance track record of the scheme over a 3 to 5 years period. Last year being an unusually bad year for the markets globally, we have listed out 10 top performing ELSS schemes. This is based on the returns generated by the scheme over a 1 year period.

Conclusion

While the option to invest in these schemes exists, you would do well to study the past performance track record of the schemes. It is also important to bear in mind that these schemes offer no assured returns and that returns generated by these schemes will be influenced by, apart from things like the state of the debt and equity markets, by the fund management skills of the fund manager.