The Deal
Your investment upto Rs 10,000 in any tax-planning fund gets a tax rebate of 20 per cent. In other words an investment of Rs. 10,000 reduces your tax-liability by Rs 2000. These funds should be looked at as a regular long-term saving which also gets tax rebate. You can only have a marginal allocation of Rs 10,000 of your available Rs 60,000 investment limit under Section 88. But it is the only tax-saving vehicle available, which does not earn guaranteed fixed-income (NSC and PPF) but provides capital appreciation. Some of these funds can also give dividend.

The product
These funds are like any other diversified equity fund with the only difference that your investment is locked for three years. This allows a fund manager to take a long-term view on his investments without worrying about redemption. This also prevents the participation of short-term investors in mutual fund trying to time their investments. That apart, the lock-in keeps dividend strippers at bay when the fund declares a dividend.

The compromise
You cannot take your money out for three years from investment in a tax saving equity fund. It looks like a compromise on liquidity. But you will be better off viewing your investment in these funds beyond three years.

The right strategy
As most of the fund families today offer an open-end tax saver, you can invest regularly - every month or quarter, than wait for the financial year-end. This way you are average your investment without worrying about your point of entry and state of the equity market and plan your savings with greater ease. A small monthly saving of Rs 830 amount to Rs 10000 in a year. And all funds offer a regular investment plan.

To illustrate the power of regular saving in an equity fund, where you also save on tax, I assumed a monthly investment of Rs 1000, which gave an annualised return of 20 per cent, close to the long-term average return from BSE Sensex. After 120 months, your regular saving of Rs 1.2 lakh becomes Rs 3.39 lakh.

The other strategy for the marginal tax-payer is to invest Rs 10000 in for three years and then dis-invest to reinvest to get the tax break. Following this strategy, after three years you can put a brake on your tax-saving investments and yet get the tax rebate. For instance, your investment of Rs 10,000 grows to Rs 15,000 after three years. Here, you can redeem the entire amount, pay a 10 per cent long-term tax on capital gains of Rs 5000 (Rs 500), re-invest Rs 10,000 and go home with Rs 4500. But the only downside is that in some years, you may not realise the capital as three-year is not a long enough time frame for equities to deliver positive returns.

It might look small saving but with your disciplined regular savings, you can well turn its into a sizeable nest egg.

-- Value Research