With tax-saving mutual funds, investors can enjoy the benefit of capital appreciation as well as tax saving.
Come December and many working individuals will have to submit their proof of investment to save themselves from the tax bite. One can actually save tax by investing in mutual funds to get tax deduction up to Rs 1.50 lakh under Section 80C of the Income Tax Act, 1961. Investing in tax-saving mutual funds has become one of the sought-after tax-saving tool by individual taxpayers in the country. With tax-saving mutual funds or equity-linked savings scheme, investors can enjoy the benefit of capital appreciation as well as tax saving. However, to save tax on mutual funds, here’s a list of 10 commandments that need to be followed by an investor to invest wisely and gain tax benefits.
1. Invest for long term
Equity markets are highly volatile in nature and the value of your investment can go up or down based on the movement of the market, which may leave you in a dilemma. Therefore, when investing in equities, you have to keep in mind the basic strategy, i.e. have patience. Investing in mutual funds for long term is the key to reaping maximum benefits even on the tax front.
2. Analyze the tax ratio cost
When investing in tax-saving mutual funds, understand the tax ratio cost, i.e. the impact of the tax on net returns of an investment. For example, if your mutual fund earns 10% returns before taxes but the tax cost incurred by the fund reduces the overall return to 9%, then the tax cost ratio is 1% which will help you plan your mutual fund investment in a better way.
3. Invest only after checking the fundamentals
Even if you buy a bad fund at a cheap valuation, it is considered a bad investment. Similarly, a good fund can be considered a bad investment if the valuation is too high. This is because, the fundamentals of the stock catch up with the price sooner or later, thus affecting your investment. So don’t get carried away while investing. Study the fundamentals first and only then go ahead with investing. This will also help you save tax in future by reducing volatility and fear trades.
4. There is no such term as ‘Timing’
There is no such right time to invest in mutual funds. It is important for you to understand your long and short-term goals and then invest accordingly. Once you have determined your investment goals and are ready to invest, then start investing instantly as there is no such best time to make an investment in the mutual fund market. Trying to time the markets generally results in unnecessarily increasing your tax burden even if you catch it right.
5. Invest in equity MFs if you are a risk taker
Most of the investors today prefer to look at the returns offered by an investment option. Though tax-saving mutual funds are likely to offer good returns in comparison to tax-saving bank deposits that offer 6.5% to 7% rate of return, however, it is important for an investor to understand that tax-saving mutual funds are likely to invest 80% of their money in the share market. And most of the times, an investor’s money is fully invested in shares to maximize the rate of returns. This means that an investor should be fully prepared to bear the behavior of the share market. Share markets turn from time to time and with a tax-saving mutual fund, an investor cannot exit the fund before the mandatory three-year lock-in period. However, if an investor is ready to take the risk, then he can get capital appreciation and enjoy tax benefits of up to Rs 1.5 lakh.
6. If you have a low-risk appetite, invest in debt mutual funds
If you don’t want to take much risk with your investment, then invest in debt mutual funds that come with growth option. Debt mutual funds invest your money majorly in debt-related instruments such as liquid funds, fund of funds, short-term debt funds and others. Opting for investing in debt funds lets an investor enjoy the benefit of indexation.
7. Invest in dividend option for a regular income
Opting for dividend option in a mutual fund is best suited for an investor who is a senior citizen or is looking to gain regular income. However, an investor should know that the rate of returns in such mutual fund type is not fixed and an investor may get lower returns than other investment schemes in some cases.
8. Opt for growth option if you are a patient investor
Under a growth mutual fund, the dividend earned on an investment is not paid to the investor but is invested back into the fund to purchase more units. Due to this, the value of an investor’s investment grows significantly. This fund option is appropriate for an investor who is not looking for a steady income but is aiming for a good capital.
9. Option of SIP investment
One of the best ways to sail through the market volatility is to opt for Systematic Investment Plan, i.e. SIP, as it allows an investor to invest money in tax-saving mutual funds on a monthly basis. Investing through the SIP mode gives an investor the benefit of rupee-cost averaging.
10. Start investing early
It is always a wise idea to avoid last-minute tax saving as investing early in ELSS comes with a host of benefits. By starting to invest early, an investor can save tax efficiently and also capitalize more on the returns. Also, the last minute paperwork and mistakes can be avoided.
11. Don’t forget your ELSS investment
Most of the investors today invest money in tax funds and forget about it, thinking that the job is over only by investing. However, this is not the case as the real job of the investor starts when the investment is made, as it is important for an investor to periodically review and monitor his ELSS investment. This is important as it gives an investor an idea if his decision was correct if the fund still fits his investment goals, etc. If the need is, the investor can take a preventative action.
(By Abhinav Angirish, Founder, Investonline.in)