It’s that time of the year again. Everyone is pouring over their salary slips trying to figure out what their tax situation is and how much can be saved by making section 80C investments. The normal behaviour of all disorganised tax-payers (meaning about 99% of us) is to make brave claims to employers’ accounts departments about the vast investments they intend to make under 80C. Come February or March and the accountant asks for proof and then we realise that we’ve forgotten about the investments. And then we hurriedly do whatever the first self-appointed investment advisor suggests and that’s that.
Till 2005, this approach was sort of OK. Till that year, the government specified what you could do with the Rs 70,000 worth of tax-saving investment that was permitted. Tax-payers had no real choice about how much investment to make into what asset class of investments. The 2005 budget not only raised the limit to a lakh of rupees, but also gave investors full freedom to decide what asset class to put the money into. For many tax-payers, a good chunk of the Rs 1 lakh gets taken care of as their PF contribution. For the remaining amount, the best choice for anyone with a longish horizon is to put it entirely in a tax-saving equity fund. This is a class of funds that are expressly intended for this purpose. They have a lock-in of three years, as the law demands, and the corpus is invested only in equity. This is not a great time to be talking about equity investments.
The crash of 2008 (and the economic crisis that caused it) has put most of us in an extremely safety-first frame of mind. However, the crash of 2008 is the very reason that it makes so much sense to invest in equity funds now. The three-year lock-in means that these investments are necessarily long-term. At the low levels that stocks are right now, a three-year investment would be as close to a guaranteed deal that an equity investment can ever be. The best way to make substantial and safe profits from equity investments is to invest for a longish period just after a market crash. This is the right time to do it and tax-saving funds are the right medium to do it through. Although the most logical way of investing this money would be to put in 1/12th of it every month though an SIP, this is one year when not doing that has not proven to be harmful since stock prices are now about the lowest in the financial year.
In recent years, fund companies have started offering a way for investors to recover part of their money long before the three years’ lock-in is over. What funds do is to pay a large dividend a few before March 31. This is often promoted by fund salesmen as a neat trick, which effectively gets you the tax rebate without having to invest as much as needed. Unless you are utterly hard-up for every rupee, don’t take the dividend option.There are two reasons for this. One, mutual fund dividends are not really dividends. Instead they are just redemptions under a disguise. If the NAV is Rs 15 and the fund gives out a Rs 2 dividend, then the NAV falls to Rs 13. Regardless of what the fund salesman says or implies, a mutual fund dividend is just your money being redeemed and given back to you. The other reason for not taking this dividend route is simply because you lose the gains you will make. Since equity profits are tax free if held for more than a year, tax-saving funds are that rare equity investment where your investments, returns and principal are all tax-exempt. All in all, the advantages vis-?-vis the alternatives are quite clear.
The author is CEO, Value Research