How to invest in tax saving mutual funds

Habits help us through our lives and many things that we take for granted, can be best credited if one analyses how the situation would be if one was not used to a routine. Even when it comes to our finances, there are certain inherent habits that we have acquired – some are good and some could be worked on for better results. Take for instance a regular income helps us to put several acts in order – rent, savings, tax savings and expenses among other routine day-to-day activities.

Yet, chances are we have developed the habit to earn and spend far easily than focus on tax savings. One of the reasons for the skew towards spending is that it is far easy and tangible with instant gratification compared to savings, which one would be able to appreciate in the future. It is for this reason that most taxpayers tend to start exploring the tax savings options available to them towards the end of the financial year. By getting into tax savings late in the day, one tends to miss out on exploring all the available options with a fine tooth comb. There is also an avoidable opportunity loss if one had started the tax saving exercise early in the financial year.

For salaried taxpayers, a significant component of tax savings is contributed through provident fund deductions that are automated by the employer each month or any other form of pension as mandated. The Section 80C of the Income Tax Act, under which Rs 1.5 lakh can be deployed in the listed financial products to avail tax benefits, offers a wide choice, including PF contributions. In fact, the wide variety of financial instruments that qualify for tax savings, often lead to bias in choosing a certain type of instruments.

But one of the most interesting instruments within this choice is the Equity-linked savings scheme or ELSS. As the name suggests, it is an equity-linked mutual fund and the advantage of deploying tax savings into an ELSS is two-pronged – you save on taxes and the equity exposure provides the opportunity for wealth creation. After all, equity is an asset class that over the long-term has generated better returns than most other asset classes. At the same time, money in ELSS has the shortest lock-in period of three years compared to other tax saving instruments available to taxpayers. Taxpayers, who have never been exposed to equity investments, could consider this avenue as their first equity investment. The short lock-in and tax savings combine a good reason to invest in the ELSS segment.

Making ELSS work for you

Having figured that ELSS has advantages over other tax saving instruments, it is important that you do not wait for the last date to put money towards tax savings in them. Just the way you get a regular salary, and your pension contribution is made every month; opt for a SIP (Systematic Investment Plan) when investing in ELSS. The advantage in spreading your tax savings through the year is obvious – you are not left with last minute decision on selecting a fund to invest. You also do away with the market noise, which would react to volatility and other factors; influencing your decision-making.

Moreover, by being regular with your investments in ELSS, you will develop the habit of regular investing as well as tax savings, which will help you from staring at the last minute tax saving decisions, which could work against you for the hurried decision that you may have to make in choosing a product. By planning your tax savings investments at the beginning of the financial year; you have the advantage of planning your other financial needs without the worry of funds to meet them. Likewise, an automated process towards tax savings each month will ensure you develop the habit of regular investing.

There are other benefits of regular investing in equities; for instance, it is well known that equity markets tend to be volatile and if investors invest at the wrong level when risk-reward might not be favourable, it may result in sub-optimal returns. Effectively instead of trying to time your ELSS investment; initiate an SIP and the rest will fall in place. As the money is invested through the year, the cost gets averaged and ensures that you get optimal returns over a period of time. In addition, by using SIPs, you can avoid the emotions involved in investing and marketing timing. You also do away with the concern of not maximising your tax savings till the last date.

Make sure you deploy the sum you can under Section 80C into an ELSS and plan your taxes for the next financial year in a better way. Start with a regular sum that you need towards tax savings and as you get closer to the financial year, increase the sum if you foresee any shortfall in your Rs 1.5 lakh limit under the Section 80C limits. Investing in mutual funds like ELSS allows you to increase your investments as and when you need, providing you the much-needed flexibility with your monies.

Here is a new habit to save taxes and an opportunity to build wealth with regular investments into equities. This act will help you realise that over time tax savings would be a by-product to wealth creation that you achieve through investments in ELSS. Now, this is one habit, which I am sure you would want to get into immediately. So, what are you waiting for?

(The writer is Fund Manager-Equity, DHFL Pramerica Mutual Fund)