Steps for investing in a tax-saving fund (Indian Economy)

Investments of upto Rs 100,000 in tax-saving funds are eligible for deduction under Section 80C of the Income Tax Act. This has opened up a new spectrum for investors while conducting their annual tax-planning exercise. In the earlier tax regime (under Section 88) the ‘eligible’ limit for investments in the tax-saving funds segment was set at Rs 10,000. In view of the renewed interest in the segment, we present a 5-step strategy for investing in tax-saving funds.

1. Assess your risk profileTax-saving funds (also termed equity-linked savings schemes) are high risk investment propositions which are ideally suited for investors with a commensurate risk profile. Investors would do well to conduct an honest appraisal of their risk appetite before investing in a tax-saving fund. Investors should resist the temptation of going overboard in tax-saving funds with the view to clock higher returns. The principles of asset allocation and diversification are equally applicable while conducting the tax-planning exercise. Hence conventional assured return investment avenues like Public Provident Fund (PPF) and National Savings Certificate (NSC) among others should also find place in investors’ portfolios along with tax-saving funds in the appropriate proportion.

2. Compare returns over a 3-Yr period Investments in tax-saving funds are subject to a mandatory 3-Yr lock-in period; hence the latter should be treated as a minimum time frame for evaluating performances. While some funds might ‘ride the wave’ and deliver impressive performances over shorter time periods, it is the ability to consistently deliver over longer time frames which needs to be acknowledged. Also investors can get an insight into the tax-saving fund by studying performances of other equity-oriented funds managed by the same fund manager.

3. Compare performance on other parametersInvestors must look beyond just net asset value (NAV) appreciation while assessing a tax-saving fund. The fund’s performance on parameters like Standard Deviation and Sharpe Ratio needs to be considered. Standard Deviation measures the degree of volatility which a fund exposes its investors to; similarly Sharpe Ratio is used to measure the returns delivered per unit of risk borne. Find out how the fund measures up on these parameters vis-à-vis its peers from the tax-saving funds segment. · Investing to save tax? Personalfn can help you. Click here!

4. Evaluate the fund houseThe fund house will play a vital role in determining how the tax-saving fund is managed. Process-driven fund houses are known to lay down policies and guidelines which encompass the entire fund management activity, for example upper limits can be set on the holdings in each sector and/or stock. Hence the likelihood of an individual’s bias influencing the fund management process is reduced. Conversely there are fund houses which are fund manager-driven i.e. the fund manager has a free hand in fund management activities. Investors’ interests are likely to be best served in a process-driven fund house. Find out what kind of a fund house your chosen tax-saving fund belongs to; your investment advisor should be able to aid you in better understanding the same.

5. Select the dividend optionAlthough the choice between the growth and dividend option should be determined by the investor’s need for liquidity, tax-saving funds present a slightly different proposition. The dividend option enables investors to capture any growth in the scheme during the lock-in period; also it takes care of investor’s liquidity needs which are otherwise constrained by the growth option.