Worldwide, the Mutual Fund, or Unit Trust as it is called in some parts of the world, has a long and successfulhistory. The popularity of the Mutual Fund has increased manifold. In developed financial markets, like the United States, Mutual Funds have almost overtaken bank deposits and total assets of insurance funds. As of date, in the US alone there are over 5,000 Mutual Funds with total assets of over US $ 3 trillion (Rs. 100 lakh crores). In India,the Mutual Fund industry started with the setting up of Unit Trust of India in 1964. Public sector banks and financial institutions began to establish Mutual Funds in 1987. The private sector and foreign institutions were allowed to set up Mutual Funds in 1993. Today, there are 36 Mutual Funds and over 200 schemes with total assets of approximately Rs. 81,000 crores. This fast growing industry is regulated by the Securities and Exchange Board of India (SEBI).
What is a mutual fund?
What are the types of mutual fund schemes?
Why should you invest in mutual funds?
How do you understand and manage risk?
How to invest in mutual funds?
What are your rights as a mutual fund unitholder?
What Is a Mutual Fund ?
A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. Anybody with an investible surplus of as little as a few thousand rupees can invest in Mutual Funds. These investors buy units of a particular Mutual Fund scheme that has a defined investment objective and strategy The money thus collected is then invested by the fund manager in different types of securities. These could range from shares to debentures to money market instruments, depending upon the scheme's stated objectives. The income earned through these investments and the capital appreciation realised by the scheme are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.
Types of mutual fund schemes
There are a wide variety of Mutual Fund schemes that cater to your needs, whatever your age, financial position, risk tolerance and return expectations. Whether as the foundation of your investment programme or as a supplement, Mutual Fund schemes can help you meet your financial goals.
(A) By Structure
These do not have a fixed maturity. You deal directly with the Mutual Fund for your investments and redemptions. The key feature is liquidity. You can conveniently buy and sell your units at net asset value ("NAV") related prices.
Schemes that have a stipulated maturity period (ranging from 2 to 15 years) are called close-ended schemes. You can invest directly in the scheme at the time of the initial issue and thereafter you can buy or sell the units of the scheme on the stock exchanges where they are listed. The market price at the stock exchange could vary from the scheme's NAV on account of demand and supply situation, unitholders' expectations and other market factors. One of the characteristics of the close-ended schemes is that they are generally traded at a discount to NAV; but closer to maturity, the discount narrows. Some close-ended schemes give you an additional option of selling your units directly to the Mutual Fund through periodic repurchase at NAV related prices. SEBI Regulations ensure that at least one of the two exit routes are provided to the investor.
These combine the features of open-ended and close- ended schemes. They may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV related prices.
(B) By Investment Objective
Aim to provide capital appreciation over the medium to long term. These schemes normally invest a majority of their funds in equities and are willing to bear short- term decline in value for possible future appreciation.
These schemes are not for investors seeking regular income or needing their money back in the short-term. Ideal for:
Aim to provide regular and steady income to investors. These schemes generally invest in fixed income securities such as bonds and corporate debentures. Capital appreciation in such schemes may be limited. Ideal for:
Aim to provide both growth and income by periodically distributing a part of the income and capital gains they earn. They invest in both shares and fixed income securities in the proportion indicated in their offer documents. In a rising stock market, the NAV of these schemes may not normally keep pace, or fall equally when the market falls. Ideal for:
*Investors looking for a combination of income and moderate growth.
Money Market Schemes
Aim to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer, short-term instruments, such as treasury bills, certificates of deposit, commercial paper and inter- bank call money. Returns on these schemes may fluctuate, depending upon the interest rates prevailing in the market. Ideal for:
* Corporates and individual investors as a means to park their surplus funds for short periods or awaiting a more favourable investment alternative.
Tax Saving Schemes
These schemes offer tax rebates to the investors under tax laws as prescribed from time to time. This is made possible because the Government offers tax incentives for investment in specified avenues. For example, Equity Linked Savings Schemes (ELSS) and Pension Schemes. Recent amendments to the Income Tax Act provide further opportunities to investors to save capital gains by investing in Mutual Funds. The details of such taxsavings are provided in the relevant offer documents. Ideal for:
* Investors seeking tax rebates.
This category includes index schemes that attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50, or industry specific schemes (which invest in specific industries) or sectoral schemes (which invest exclusively in segments such as 'A' Group shares or initial public offerings). Index fund schemes are ideal for investors who are satisfied with a return approximately equal to that of an index. Sectoral fund schemes are ideal for investors who have already decided to invest in a particular sector or segment. Keep in mind that any one scheme may not meet all your requirements for all time. You need to place your money judiciously in different schemes to be able to get the combination of growth, income and stability that is right for you. Remember, as always, higher the return you seek higher the risk you should be prepared to take. A few frequently used terms are explained here below:
Net Asset Value ("NAV")
Net Asset Value is the market value of the assets of the scheme minus its liabilities. The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the Valuation Date.
Sale Price Is the price you pay when you invest in a scheme. Also called Offer Price. It may include a sales load.
Repurchase Price Is the price at which a close-ended scheme repurchases its units and it may include a back-end load. This is also called Bid Price.
Redemption Price Is the price at which open-ended schemes repurchase their units and close-ended schemes redeem their units on maturity. Such prices are NAV related.
Sales Load Is a charge collected by a scheme when it sells the units. Also called, 'Front-end' load. Schemes that do not charge a load are called 'No Load' schemes.
Repurchase or 'Back-end' Load Is a charge collected by a scheme when it buys back the units from the unitholders.
Why Should You Invest In Mutual Funds ?
The advantages of investing in a Mutual Fund are:
Understanding And Manager Risk.
All investments whether in shares, debentures or deposits involve risk: share value may go down depending upon the performance of the company, the industry, state of capital markets and the economy; generally, however, longer the term, lesser the risk; companies may default in payment of interest/ principal on their debentures/bonds/deposits; the rate of interest on an investment may fall short of the rate of inflation reducing the purchasing power. While risk cannot be eliminated, skillful management can minimise risk. Mutual Funds help to reduce risk through diversification and professional management. The experience and expertise of Mutual Fund managers in selecting fundamentally sound securities and timing their purchases and sales, help them to build a diversified portfolio that minimises risk and maximises returns.
How To Invest In Mutual Funds ?
Step One - Identify your investment needs.
Your financial goals will vary, based on your age, lifestyle, financial independence, family commitments, level of income and expenses among many other factors. Therefore, the first step is to assess your needs. Begin by asking yourself these questions:
Once you have a clear strategy in mind, you now have to choose which Mutual Fund and scheme you want to invest in. The offer document of the scheme tells you its objectives and provides supplementary details like the track record of other schemes managed by the same Fund Manager. Some factors to evaluate before choosing a particular Mutual Fund are:
Investing in just one Mutual Fund scheme may not meet all your investment needs. You may consider investing in a combination of schemes to achieve your specific goals. The charts could prove useful in selecting a combination of schemes that satisfy your needs.
Step Four - Invest regularly
For most of us, the approach that works best is to invest a fixed amount at specific intervals, say every month. By investing a fixed sum each month, you buy fewer units when the price is higher and more unitswhen the price is low, thus bringing down your average cost per unit. This is called rupee cost averaging and is a disciplined investment strategy followed by investors all over the world. With many open-ended schemes offering systematic investment plans, this regular investing habit is made easy for you.
Step Five - Keep your taxes in mind If you are in a high tax bracket and have utilised fully the exemptions under Section 80L of the Income Tax Act, investing in growth funds that do not pay dividends might be more tax efficient and improve your post-tax return. If you are in a low tax bracket and have not utilised fully the exemption available under Section 80L, selecting funds paying regular income could be more tax efficient. Further, there are other benefits available for investment in Mutual Funds under the provisions of the prevailing tax laws. You may therefore consult your tax advisor or Chartered Accountant for specific advice.
Step Six - Start early
It is desirable to start investing early and stick to a regular investment plan. If you start now, you will make more than if you wait and invest later. The power of compounding lets you earn income on income and your money multiplies at a compounded rate of return.
Step Seven - The final step
All you need to do now is to get in touch with a Mutual Fund or your agent/broker and start investing. Reap the rewards in the years to come. Mutual Funds are suitable for every kind of investor-whether starting a career or retiring, conservative or risk taking, growth oriented or income seeking.
Your Rights As A Mutual Fund Unitholder
As a unitholder in a Mutual Fund scheme coming under the SEBI (Mutual Funds) Regulations, ("Regulations") you are entitled to:
Is trading through the Internet safe?
What about security of my money, demat shares and my transaction documents?
Isn't trading through the Internet a difficult and cumbersome process?
But I am not comfortable with Internet, or with finance, how can online trading be easy for me?
Isn't trading through the Internet a costly affair?
I am pretty satisfied with my present broker who serves me offline.Why should I choose to go online to trade shares?
How frequently is the prices updated at all these online trading sites?
How can I be sure that I shall be trading at a price I want to or at a ricpe appearing in the website?
What other services can I get by trading shares online?
Is trading through the Internet safe?
The safety of transactions on the Internet depends on the encryption system used. The better this transaction system, the more difficult it is for any person to hack the site.
Internationally, the best system available today, is the 128-bit encryption, a system, which even the Pentagon uses. ICICIdirect.com is one of the few online share-trading sites in the country equipped with this 128-bit encryption.
Secondly, you too can ensure the safety of the transactions online.You normally get a secured user id and password, the secrecy of which is to be maintained entirely by you.
Thirdly, if the transaction system requires no manual intervention, you further improve the safety in the transactions. Among Indian sites, ICICIdirect.com is one of the very few fully integrated online trading sites. This enables the elimination of the possibility of any manual intervention. Which means orders are directly sent to the exchange ensuring that you get the best and right price.
What about security of my money, demat shares and my transaction documents?
In systems where the broking, banking and demat accounts are completely integrated, your money remains in your own bank account, and does not get transferred to the broker's pool account.
Is trading through the Internet a difficult and cumbersome process?
The experience of trading through Internet depends a great deal on the type of product offered by the site. Say, for example, one of the issues bothering you may be tired of the paperwork involved after every trade in writing cheques or TIFDs.
You would then seek a system that eliminates these processes.
In online trading sites, the greater the back-end integration of the system, the greater the amount of work the sites do for you, therefore greater the convenience available to you.
For example, incase of SASOnline.in, your broking account, bank account and demat account are linked electronically. So when you punch in a buy or sell order, the system checks the funds/ shares availability and automatically credits/debits the accounts once the order is executed by the exchange.
But I am not comfortable with Internet, or with finance, how can online trading be easy for me?
Contrary to common perceptions, trading through Internet does not require either any expertise in working on the computer, or any special financial skills.
You could try the demo (demonstration) of the online trading sites like SASOnline to find out why others like you, with little or no knowledge about the Internet or finance, have switched on to online trading. Or you could attend the demonstrations sessions held by such websites in your city.
Is trading through the Internet a costly affair?
The convenience provided by online trading is even then worth the costs involved.
And online trading sites are not that costly. For example, a trader can trade shares on margin at rates as low as 0.02%*on SASOnline and if one wishes to trade in cash, then the rates applicable are as low as 0.15%*.
I am pretty satisfied with my present broker who serves me offline. Why should I choose to go online to trade shares?
Many of those customers who have chosen to trade shares online today, had at one point of time been trading through offline brokers, just like you are today. They took a chance to go online and trade shares. After realising the advantages of trading shares online, they have shifted to online trading now. In fact, there are more than a lakh customers who have already opened an account with SAS Online. Just try trading shares after opening an account with any online trading site. However, before choosing an online trading site, please compare all such websites and then make a decision.
How frequently is the prices updated at all these online trading sites?
The tickers available at online trading sites provide instantaneous updates. Also, some websites can offer to transact in those shares instantaneously and with convenience.
How can I be sure that I shall be trading at a price I want to or at a price appearing in the website?
The solution to your problem could be provided in different ways by different online share trading sites. At ICICIdirect.com, for any trade order, the customer is asked to click "Proceed" after he has the opportunity to completely check the order verification form.
Moreover, you have the option of modifying or canceling the order till the moment the order is executed at the exchange.
Finally, online trade confirmations reach reaches our customers within 4 minutes, while contract notes are dispatched at the end of the day and reach within 24-36 hours.
With ICICIdirect, you decide what you want to buy and buy the share at the price you want to and therefore you are in total control of your trades.
What other services can I get by trading shares online?
Internet has brought to the retail investores what was till sometime ago the sole prerogative of large brokerage houses and high net worth individuals. For example at ICICIdirect.com one can access multitude of resources to arrive at his stock picks. Reliable research with an enviable track record is available free of cost.
An investor can now access ICICIdirect.com and do his technical analysis, know what other leading brokers think about a company and whether it is a buy or a sell, (Multex Global estimates), access live news from international news agencies such as Reuters, CNBC, read about what the leading CEOs think about the state of the economy and the capital market.
Financial planners believe - that most young earners invest their money in low yield instruments and hence are losing good returns on that amount. Investment consultant Sandeep Shanbhag says, “While the recurring deposit is a good savings habit, the interest thereon may not be enough even to cover inflation.”
The year-end savings of such people are mostly a picture of neglect. Commenting on this, Investment Advisor, Ajay Bagga says, “Their year end planning is more a tax minimisation plan, rather than one that would meet their financial goals in the long term.”
The most prominent recommendation or the ideal portfolio that all experts have for this profile of people is to increase exposure to equity. Shanbhag says, “The only time when you can take advantage of equity without sweating the risk is when you are young. Fixed income will gradually follow along with age”.
Bagga also seems to agree. He says, “For someone with this profile, I would recommend a portfolio that has 90% in Equity Mutual Funds, and 10% in fixed return products like PPF, Recurring Deposits, Bank Deposits”.
“All investments must be made on three criteria, the investors risk appetite, time horizon and financial goals,” feels Bagga. “Both these ladies are young professionals, with a long time for retirement. This is the time for them to maximise their long term returns by investing in equity assets like mutual funds,” he adds.
On the recurring deposit, while both experts agree that it is a good habit, they feel that it can be looked at purely for the purpose of diversification. “A systematic investment plan (SIP) in a diversified mutual fund scheme, which is like an RD itself would prove more beneficial”, suggests Shanbhag.
Another interesting point is that both of them have parked a significantly large amount of money in their savings account. Shanbhag says, “While everybody has to keep some amount in the bank for day-to-day requirements and emergencies, the rest should be invested in short-term (money market) mutual fund schemes. In these, the returns are higher and the liquidity is great (you can get your money back in 3-4 days).”
Bagga suggests that around 6 times the monthly expenditure can be kept in a liquid asset like a bank deposit, as an emergency pool.
Do you really need insurance?
Bagga says, “I would recommend that Manasi relook her insurance coverage and see if she really has dependants whom she needs to cover, or did she buy the policy due to the agents push and to save tax only. She should try to switch to a low cost term insurance policy, which all companies offer, but which no agent sells, as the commissions are too low on these.”
Shanbhag seems to mirror these views, “Deshmukh’s insurance premium seems to suggest that she has bought an endowment or money back policy. If she has no dependents, then buying insurance, especially endowment, is sub optimal. In any event, she should not buy more insurance hereon.”
Save tax but don’t compromise on returns
Most people prefer investments by way of bonds, NSC, PPF, LIC, for tax saving. However, Equity Linked Saving Schemes (ELSS) appear to be the flavour of the moment. Says Bagga, “Stop contributing to NSC. The returns are not comparable to equity and the lock-in is long”
Shanbhag recommends, “You can invest in ELSS instruments. This way, you can kill two birds with one stone, up your exposure to equity and simultaneously save tax.” “Bonds yield very little interest and now that sectoral caps have been removed, one should invest in ELSS instruments,” he adds.
Bagga does not think that infrastructure bonds are very good investments too, “The returns on infrastructure bonds have fallen to the 5-5.5% levels. Their only attraction used to be the tax savings. With Sec 80 C now allowing investors the freedom to choose whichever investment they want to make freely up to Rs 1 lakh per annum, these are no longer an attractive option given the low returns and taxable interest nature of these bonds. Manasi should not invest in these in the future.”
Expert speak: Tips to invest in mutual funds
Investment is an art. And not everybody has this skill. However, those who do not possess this skill, still need to make investments. The more you maximise the return by effectively utilising the money earned or saved by you, the better.
For those who do not possess this 'investment skill', there is a great route available -- mutual fund schemes. This is a different animal. A simple one, with lots of variety, it comes in all shapes and sizes to suit every investor's requirements.
In this article, without going into the basics of mutual funds, let me try and address some questions that investors have asked me at various points of time.
How long should I stay invested?
A typical quandary for most of the investors.
This is not just true of mutual funds, but in any other investment that involves a lot of volatility. Let me stick to mutual funds, though.
The longer you stay invested, the better. I would suggest a minimum tenure of 5 years for you to have a decent, steady return on your investment.
Well, it also matters what type of scheme you choose and when you invest. Even in mutual funds, the timing is important.
Just to cite an example, if you would have invested in a technology fund in 1998, you would have got yourself into a mess. But, if you would have invested in the same technology fund somewhere around 2002-03, you would have been better off.
The choice of right fund and right timing, therefore, is of essence.
Should I invest in growth or dividend option?
Some investors have this confusion as to which is best suited for their investment profile. Such confusion arises only because every investor worth her/his salt wants to maximise the return, ensure that the option is rightly chosen, and is also tax efficient.
If you plan to invest in an equity fund in the current scenario then capital gains in your hand is not taxable if you stay invested for more than a year. In the normal course, mutual fund investment should always be for the long term -- I would say, for 3-5 years. Therefore, you should look at investing in the growth option.
If your investment is into a debt product, you should invest in the dividend option. The dividend paid to the investor is tax free while the capital gain is taxable at 30 per cent for the short term and 20 per cent for the long term (plus surcharge and cess as applicable).
In case a dividend is paid to you, the scheme has to pay a dividend distribution tax of 12.5 per cent (plus surcharge and cess as applicable). In simple words, go for the growth option if you are investing in an equity scheme and dividend option for debt schemes.
The caveat still remains that it shall depend on the investor's tax bracket and income levels.
NFO or the existing fund?
The new fund offers (NFOs) are favourite for many investors. I cannot fathom why.
Given a situation where there is an NFO with the same objective of an existing fund, it is better to get exposed to the existing fund. As they say, `a known devil is better than an unknown angel'.
However, if there is a new theme that is being launched, it makes a lot of sense to invest in such a new theme.
Having said that, in case there is a fund launched by a fund house which is not known for its equity investment performance, and after some time another established fund house launches the same theme, it is advisable to take an exposure in the scheme of the established fund house instead of the existing one.
Therefore, such decisions are situational and there is no set formula for the same. Still, it is all a game of asset allocation.
NAV of Rs 10 or Rs 175?
Frankly, such a dilemma is unnecessary.
The net asset value, NAV, of a mutual fund scheme has no say in the returns that you receive. If the return of a fund is 40 per cent then the NAV of your fund should not matter. Be its NAV Rs 10 or Rs 200.
By that I mean that an investor A who has invested at an NAV of Rs 10 will get a return of Rs 4 per unit and the other investor B could get a return of Rs 80 per unit. But the catch is in the number of units that the investor gets. Investor A will get 1,000 units (on an investment of Rs 10,000) and investor B will get only 50 units.
Thus, the return would be Rs 4,000 for both the investors. It is as simple as this.
Should I invest in an ULIP or a mutual fund scheme?
Unit linked insurance policy, ULIP, and mutual fund schemes are different set of investments. First and foremost, your objective should be clear. Do you want an insurance cover or do you want to earn money on your investment?
My view is that you cannot mix both. With the same outflow, it would be better to take a term policy (lower premium, higher cover) and have an SIP in a good mutual fund scheme for the period of your insurance (normally 15-18 years).
You would probably make much better return in this combination than investing in an ULIP.
How do I time the market?
Even the well-known stock market legends cannot accurately time the market.
The philosophy goes 'buy low sell high'. While it is great as a philosophy, in practice it is not possible to consistently do it. That is why, for those who are risk-averse, there is this excellent facility called the systematic investment plan, SIP, and the systematic transfer plan, STP. Also, rupee cost averaging will work very well for you if you invest consistently.
Currently, there are funds that offer weekly transfer plan under STP. I am waiting for the day when mutual funds will offer daily STP that could play wonders for rupee cost averaging.
Buy ELSS funds, make money & save tax
Do you want to 'kill two birds with one stone' through smart investment-cum-tax planning?
If yes, then you should consider investing a part of your investible income in equity linked savings scheme (ELSS) of mutual funds. ELSS is an efficient investment tool that offers the twin-advantage of healthy capital appreciation and reduced tax burden. In our work-a-day life, we exert ourselves utmost to save every penny but are exasperated when taxes eat into our savings.
In order to save on tax, we have the option to invest a maximum of Rs 1,00,000 in various tax saving instruments under Section 80C of the Income Tax Act.
The eligible investments for availing Section 80C benefits include contribution to Provident Fund or Public Provident Fund (PPF), payment towards life insurance premium, investment in pension plans/ specified government infrastructure bonds/ National Savings Certificates (NSC)/ Equity Linked Savings schemes (ELSS) of mutual funds, payment towards principal repayment of housing loan (also any registration fee /stamp duty paid), and payments towards tuition fees for children to any school or college or university or similar institution (only for 2 children).
If you do a cost-benefit analysis of ELSS, PPF and NSC, then you will find that ELSS offers you manifold advantages/ benefits as compared to the other two tax savings instruments.
ELSS has a lock-in of only three years, whereas PPF and NSC have a longer lock-in period of 15 years and six years respectively. PPF and NSC fetch you a return at a compounded annual growth rate (CAGR) of 8 per cent while the average returns over three years in ELSS, which allows investors to participate in the India growth story by investing its money in shares, for the top five schemes as on November 30, 2007 is in the region of 50 per cent.
It would not be out of place at this point to slip in a caveat emptor that in the case of mutual fund investments past performance may not be sustained in future as equity markets are affected by events, global as well as domestic.
The maximum investment an individual can make in PPF under Section 80C is Rs 70,000, whereas it is Rs1,00,000 in the case of NSC and ELSS. When it comes to reaping taxation benefits, ELSS scores over PPF and NSC. As per current tax laws if you invest in ELSS, then dividend and capital gains are tax-free. While interest received in the case of PPF is tax-free, the same is not true in the case of NSC.
How to start an ELSS account?
There are two ways to invest in ELSS.
~ Invest a fixed amount every month through systematic investment plan (SIP) in ELSS and reduce the burden of large investment towards the end of financial year.
~ Invest lump sum at any point of time.
Why SIP route for ELSS?
One of the best ways to invest is to save and invest on a regular basis through SIPs. SIP is a planned investment programme, whereby an investor invests small amounts of his/her savings in mutual funds at regular intervals.
SIP helps an investor take advantage of the fluctuations in the stock markets by rupee cost averaging (in a rising equity market an investor gets fewer MF units but when the market is sliding he/she gets more MF units) and also helps him/ her reap the benefits of compounding.
A SIP in ELSS offers an investor the best combination of investments -- tax-savings and capital appreciation -- available to investors. The minimum investment in an ELSS through the SIP route can be as small as Rs 500.
By investing regularly in ELSS, the problems of wrong timing, wrong stock selection and burden towards the end of financial year is reduced substantially.
Since ELSS has a lock-in of three years, the fund manager does not face any redemption pressure. This is important as the manager has the elbow-room to allow the stocks in his/her portfolio to mature. He/ she is not under undue pressure to sell stocks which are expected to fetch good returns over a two-three year horizon.
In sharp contrast, open-ended schemes can be likened to an expressway which has an exit every 500 meters. So, when investors in an open-ended scheme go for redemption, the fund manager has no choice but to sell stocks which have the potential to grow over a two-three year period.
While choosing ELSS an investor would do well to keep in mind the size, experience, quality and consistency of fund houses over a period of time. If you are building a nest-egg and are conservative, then you should consider channeling your precious resources into ELSS even as you apportion a small part of your savings to PPF and NSC.
Time to start your tax planning
My friend was asking me if ICICI Bank [Get Quote] or IDBI Bank were going to issue any tax saving bonds that he could invest in. I asked him why on earth he wanted to invest in bonds?
His retort: Because it is mandatory for tax saving.
That's when I realised that he was still referring to the Section 88 rebate.
This year it is Section 80C!
No longer is Section 88 valid. Now think Section 80C only.
Section 88 offered a rebate. A rebate is when the government gives you a concession on your income if you invest in certain instruments.
Section 80C does not offer a rebate but a deduction from taxable income. The good news: you get a higher tax benefit.
You save more under Section 80C
The upper limit under both, Section 88 and Section 80C is Rs 1,00,000.
But that is where the similarity ends.
Under Section 88
Since the maximum amount that could be invested under Section 88 was Rs 1,00,000, the maximum tax that could be saved was upto Rs 20,000.
Let's put figures to this:
You had to pay tax = Rs 28,000
Your rebate = 20%
You invested Rs 1,00,000 in the instruments eligible for a rebate.
Your savings = Rs 20,000 of your tax (20% of Rs 1,00,000).
So instead of paying tax of Rs 28,000, you pay a tax of Rs 8,000 (Rs 28,000 � Rs 20,000).
Under Section 80C
Let's say your taxable income is Rs 100,000.
You invest Rs 70,000 in the Public Provident Fund. Your taxable income drops to Rs 30,000 (Rs 1,00,000 - Rs 70,000).
So if you up to Rs 1,00,000 invest in the relevant instruments, you save tax upto that amount.
Section 80C is for everyone
That's right. No more discrimination.
Under Section 88, the rebate varied depending on the income slab.
Anyone and everyone, irrespective of the income they earn, can avail of the benefit under Section 80C.
Section 80C gives more investment flexibility
No more sub-caps.
The maximum amount under Section 88 (Rs 1,00,000) has several sub-caps.
For instance, a maximum of Rs 10,000 in Equity Linked Savings Schemes. These are diversified mutual funds with a tax benefit. They invest in the shares of various companies of various sectors.
Then there was a minimum of Rs 30,000 that had to be invested in infrastructure bonds. These were the bonds that were issued by financial institutions like ICICI and IDBI.
These restrictions do not exist anymore. There is much more freedom to select where to invest under Section 80C. You can decide how much percentage of your income can go in which investment. So, if you want to invest the entire Rs 1,00,000 in ELSS, no one is there to stop you.
You don't have much time for the financial year to end. Don't wait for the last minute to do your investments. Specially if you want to invest in ELSS.
Here you buy the mutual funds units depending on the current Net Asset Value (price of a unit of a fund). And the NAV could rise or fall depending on the stock market.
You can space out your investments over four months (December, January, February and March) to avoid timing the market. Decide how much you want to invest in the funds for this financial year, break it up into four installments and start investing via a Systematic Investment Plan right away.
What falls under Section 80C?
In Time to start your tax planning, we explained why Section 80C is better than Section 88.
Over here, we tell you what qualifies for exemption under Section 80C.
1. Contribution to Provident Fund
2. Contribution to Public Provident Fund
3. Payment of life insurance premium
4. Investment in pension plans
5. Investment in Equity Linked Saving Schemes of mutual funds
6. Investment in Infrastructure bonds
7. Investment in National Savings Certificate
1. Payments towards the principal amount of your home loan are eligible for an income deduction.
2. Payments towards the education fees for children are also eligible for an income deduction.
Overall, the limit under Section 80C is Rs 1,00,000. Unlike Section 88, there are no sub-limits.
This is irrespective of how much you are earn and under which tax bracket you fall.
However, there may be individual limits under each.
For instance, the maximum that you can invest in PPF is Rs 70,000 per annum.
Also, under Section 80CCC, the contribution made to pension funds is subject to a maximum of Rs 10,000.
Barring these exceptions, you can choose to invest the entire amount in ELSS or infrastructure bonds. The choice is entirely up to you as to how you want to reach this limit.
Or, if you are repaying a home loan and the principal repayment amounts to Rs 1,00,000, you can claim the entire amount as a deduction.
Similarly, the deduction for tuition fees under Section 80C is available towards payment of education fees for children upto a ceiling of Rs 1,00,000. However, in order to avail of this deduction, you will have to produce the fee receipt.
Where to invest to save tax
It's that time of the year when everyone starts thinking about taxes. Or rather, what to do to minimise them.
This time around, the tax payer has the going a little more easy. After all, Section 80C is certainly better than the now defunct Section 88.
Section 80C offers tremendous flexibility in determining where your money should go.
Basically, the list of investments that qualified under Section 88 also appear in the new Section 80C. The good news is that the internal caps put on the investments have been taken out and you get to decide how much to invest where. As long as it all falls within the Rs 1,00,000 limit.
To understand the difference between Section 88 and Section 80C, read Time to do your tax planning.
Here we present the best investing options for those in their twenties.
This is a classic example of where you should NOT invest.
In What falls under Section 80C we drew the entire list of investments that are covered for tax exemption. However, that certainly does not imply you should be investing in all those avenues.
You need to wisely select those that will fit your profile.
Under Section 88, everyone was virtually forced to invest in these bonds. Under the overall cap of Rs 1,00,000, Rs 30,000 was exclusively reserved for these bonds. If you did not invest in the bonds, you lost out.
This is no longer the case. Investment in infrastructure bonds falls under the overall Section 80C limit of Rs 1,00,000 with no separate cap. So you have the choice of bypassing it for another investment. Please do so.
These bonds will offer a return of around 5.5% to 6% per annum with a lock-in period from three to seven years. The returns are poor and at this stage in your life, there is no need to even consider such an avenue.
Equity Linked Saving Schemes
This is an investment you MUST consider.
ELSS are diversified equity mutual funds with a tax benefit under Section 80C. Diversified equity mutual funds are those that invest in the shares of various companies of various sectors.
Since you are young, you have time on your side to ride the ups and downs of the stock market. Moreover, stocks should be part of your investments because not only do they add that extra zing to the portfolio, but they also give the best returns over the long term.
Initially, under Section 88, there was a cap of Rs 10,000 on the investments made in ELSS. You could not invest more than that in these funds. Under Section 80C, there is no cap on this investment. If you choose, you can invest right up to Rs 1,00,000 in this investment option.
Investments in ELSS have to stay locked in for a period of at least three years. And, the returns can be great.
The best tax saving funds are Franklin India Taxshield, HDFC [Get Quote] Long Term Advantage Fund, HDFC Taxsaver, Magnum Taxgain and Prudential ICICI [Get Quote] Tax Plan.
To view a detailed analysis of these funds, read The best tax saving funds.
Public Provident Fund
PPF is a great long-term investment strategy.
Please do not confuse this with the EPF. Employers usually provide an Employee Provident Fund for their employees.
A percentage of the salary is deducted as Provident Fund and, generally, the employer contributes as much as the employee contributes into the fund.
Since this is automatically done, you don't need to worry about it. Your contribution to the provident fund is eligible for deduction under Section 80C.
The PPF is a government run fund where the entire contribution is voluntarily made by the individual himself.
The maximum that can be invested in a financial year (April 1 - March 31) is Rs 70,000. Here you will get a return of 8% per annum.
Your money will be locked for a period of 15 years. It may seem like a long time but will work to your benefit if you use it as a long-term retirement investment option.
Since the minimum that you have to put in every year is just Rs 500, it is easy to maintain this investment even over a long period of time.
This is one investment that offers total safety since it is backed by the government and the return of 8% is higher than what you will get from other fixed return instruments.
So if you are going to invest significant amounts in ELSS, which are inherently risky because they are equity, you could balance your investments by also investing in PPF.
That's not all
Besides ELSS and PPF (and the provident fund contribution which is done automatically), there are other options that you must look at to save tax. Though they are not investment options per se, they must form a part of your overall investment strategy.
The best tax saving funds
In Why you must invest in ELSS funds, we spoke about the returns delivered by tax saving mutual funds and why they make for a smart investment option.
Today, we look at the five best funds to park your money in.
Franklin India Taxshield
This one may look dull when compared to some of its flashy peers. Nevertheless, it remains one of the finest options in this category.
An outstanding long-term performance record coupled with extremely low volatility makes this fund apt for any tax-planning portfolio.
The fund's average performance in recent times should not worry investors. Of course, it has lagged behind some of its aggressive peers, who have earned hot returns through mid-cap and small-cap stocks. But, the consistency of this fund is hard to beat.
This fund can be your best friend in uncertain times.
In 2000, when all tax saving funds lost 22.58% on an average, this one gained 2.11%.
In 2001, when the funds lost an average of 20.49%, this fund lost just 13.33%.
Through its life, it has almost always outperformed the average returns of its peers in tough times.
From 2002 onwards, it has been delivering good returns.
The fund manager believes in buying and holding on to the stock. The average life of a stock (time the fund manager holds onto it before selling it) has been a healthy 18 months. Stocks like Infosys [Get Quote], Grasim Industries [Get Quote] and Hindalco [Get Quote] have now become permanent members of the portfolio.
Currently, the fund manager has a portfolio of around 45 to 55 stocks. It's large-cap focus and ability to protect the downside (when the stock market falls) makes this fund a worthy choice.
HDFC [Get Quote] Long Term Advantage Fund
With a portfolio laden with mid-cap and small-cap stocks, this fund has delivered an outstanding performance since its launch in December 2000.
Starting as a large-cap oriented fund, it soon realised the potential of mid-caps and small-caps. By August 2002, it began investing heavily in them. The fund ended that year as the hottest fund in the category.
Over the next two years, the exposure to mid- and small-caps increased to over 80% of the total portfolio (all the investments).
The fund has marginally changed its focus right now. With equity markets at their all-time high and more volatility, it has now invested more in large-cap and quality mid-cap stocks and cut down substantially on small-caps.
This fund is a worthy choice for all long-term portfolios.
This fund offers a rare combination of low risk and high returns. One of the least volatile funds in the category, HDFC Taxsaver has delivered an awesome 43.07% annual return since launch in March 1996.
The recent bull run has strengthened the fund's superlative track record.
In 2003, it delivered a return of 121.06% and in 2004, it delivered a return of 49.38%. Till October 26, 2005, the fund had raced ahead to give a return of 50.72% while the average return of its peers was 29.06%.
What makes this fund special is not how it exploits the booming stock market but the way it manages downside risk (when the market falls).
The year 2002 was the only rough patch in an otherwise sparkling track record of the fund. High investments in public sector undertakings and FMCG stocks and a low allocation to mid-caps dented its performance. Since then the fund has never looked back.
In recent times, the fund began investing in relatively risky but rewarding mid- and small-cap stocks. Now, with the stock market reaching such levels and turning volatile, the fund has once again started investing in large-cap stocks.
An admirable performance record, low volatility and the ability to protect returns in a bearish market make the fund special.
The oldest ELSS fund has earned enormous wealth for its investors in the last two years.
Till mid-2003, the fund had a depressing past. Since launch in March 1993, it gained a paltry 5.09% a year till June 2003. Since then, its performance chart has seen an unprecedented rise and the fund has earned an annualised return of 104% between mid-2003 and October 2005 and is miles ahead of its average peer's 56.72% return during the same period.
A greater emphasis on some well picked mid- and small-cap stocks is behind the fund's sensational turnaround.
Some of its engineering and chemical picks have performed exceptionally well during the period. Stocks like Thermax, Praj Industries [Get Quote], Havell's India, Crompton Greaves [Get Quote] and United Phosphorous proved to be lucrative investments.
As on October 31, 2005, the fund had gained 69.72% since the start of the year, more than the average returns of its peers of 27.22%.
The fund has had its share of pain and 2000 and 2001 were the most painful period in its life. It is an aggressive fund where the fund manager does not hesitate to take huge stock-specific or sector-specific bets. Therefore, you get high returns but high volatility too.
Prudential ICICI [Get Quote] Tax Plan
If sharp ups and downs in the Net Asset Value make you fret, ignore this fund. This fund is highly volatile and susceptible to market swings. However, those who keep the faith here are rewarded suitably.
The fund had a disastrous start in August 1999. It suffered huge losses when the tech boom crashed in 2000 but staged a strong comeback.
In 2001, when on an average its peers lost 20%, this fund lost just 6%. In 2002, it did not fare as well but delivered a 150% return in 2003 and 36.46% return in 2004.
The fund manager's ability to pick opportunities among lesser-known stocks early enough is praiseworthy. At times, the fund has taken huge concentrated bets.
Even exposure to small-caps has touched a high of 66%. But, the fund tries to mitigate the risk of investing in small-caps by investing across various stocks and sectors.
What you MUST know before taking a loan
December 14, 2005
What loan tenure should I opt for?" This question was posed to us by a reader recently.
Since the loan tenure is directly related to the Equated Monthly Installment, let's look at this concept first.
After you take a loan, you will have to repay part of it every single month. This is irrespective of whether it is a vehicle loan, home loan, personal loan or education loan. Repayment is always done on a monthly basis.
This amount that you repay every month is referred to as the Equated Monthly Installment.
The EMI stays constant
There are two parts to loan repayment -- the principal amount and the interest payment.
Interestingly, the EMI, which is generally a fixed amount, is an unequal combination of interest repayment and principal repayment.
Sure, there are exceptions. You could also ask for an EMI that changes over the years such as an ascending EMI or descending EMI (which means your EMI increases or reduces over the years).
The EMI is affected by tenure
The EMI may be constant but what you need to look out for is the tenure. Let's work it out with some figures.
Interest rate = 9% per annum
Loan amount = Rs 10,00,000
Tenure = 5 years / 60 months
EMI = Rs 21,424
Total amount you will pay over the 5 years = Rs 12,85,440
Interest rate = 9% per annum
Loan amount = Rs 10,00,000
Tenure = 8 years / 96 months
EMI = Rs 15,056
Total amount you will pay over the 8 years = Rs 14,45,376
Interest rate = 9% per annum
Loan amount = Rs 10,00,000
Tenure = 3 years / 36 months
EMI = Rs 32,921
Total amount you will pay over the 3 years = Rs 11,85,156
The lesser the tenure, the higher the EMI.
The lesser the tenure, the less you eventually pay to the financier.
Does that mean you should take a short tenure loan and a higher EMI?
Broadly speaking, yes. However, you will have to look at a number of factors before you reach that decision.
1. Tax benefits
If you are getting tax benefits, as you would on a home loan or education loan, then you may want to service the loan for a few years. If you are getting no tax benefits, you should look at repaying it quickly.
2. Comfort level
You may want to pay back the loan as soon as possible, but you may not be able to afford a higher EMI. In this is the case, you may have to opt for a loan with a longer tenure so you will have more time to pay it off.
3. Salary increases
If you are in a job where you foresee high increments every year, you can opt for a shorter tenure. Let's say you are paying back Rs 10,000 a month and you are earning Rs 30,000 a month. Let's further assume you are going to get a hike to Rs 38,000 per month.
Now the EMI stays constant but you are earning much more so it does not pinch as much. Opting for a shorter tenure and a high EMI makes sense if you foresee rapid or substantial increments.
4. Interest rate
If the loan has a high interest rate, it is best to pay it back as soon as possible. On your home loan, you would have got a very competitive rate. But you will be paying a high rate of interest on your personal loan. In such instances, even if it means living on tight budget, opt for a higher EMI.
Finally, you will have to work out a deal you are comfortable with. For instance, let's say your friend has taken a loan and is servicing an EMI of Rs 4,500. You may want to take the same deal.
If he is earning Rs 15,000, the EMI would be 30% of his income. But, if you are earning Rs 30,000 per month, the EMI would be just 15% of your income. Maybe you could take a higher EMI if you can afford it.
So don't go by absolute figures, see what percentage of your earnings is going towards loan repayments. Only then take a call.
Returns delivered by mutual funds
In Mutual funds give great returns, we spoke about the performance of 34 mutual funds. These funds existed for the past 10 years and hence were selected for this analysis.
1. The returns are shown over a 10-year period: July 1995 to June 2005.
2. Three types of funds are analysed:
- Diversified equity funds: funds that invest in the shares of companies of various sectors.
- Equity Linked Saving Schemes: diversified equity funds with a tax benefit.
- Balance funds with an equity tilt: funds that invest in shares of various companies as well as in fixed-return investments.
3. The returns are annualised, meaning these are the returns you would get every year.
4. Since a Systematic Investment Plan requires you to make an investment every single month, the amount is assumed as constant all through the 10-year period.
OPT FOR DIVIDEND PLAN IN ELSS – IT HAS MORE TO OFFER THAN MEETS THE EYE
A successful investment strategy involves optimisation of four factors — risk, return, liquidity and tax-efficiency. However, under current regulations, tax-saving investments are not possible beyond a certain limit.
Under section 80C of the income tax act, a total investment of Rs 1 lakh in specified avenues is eligible for deduction from the total annual income. Moreover, instruments eligible for tax benefits under section 80C come with a lock-in period of three to five years, restricting the liquidity of such investments.
Among all these instruments, the equity-linked saving scheme (ELSS) of mutual funds offer certain advantages that enable the investor not only to invest less than Rs 1 lakh to get the same tax benefit, but also earn a higher return.
Go for the dividend plan
Almost all equity-linked saving schemes have two fund options — growth and dividend. Unlike a growth plan, an investor gets annual payouts from the dividend schemes before the final redemption of units.
The trick here is to invest in the dividend plan of an ELSS. For instance, if one invests Rs 1 lakh in an ELSS, one saves a tax outgo of Rs 33,990 (at the highest tax rate of 33.99 per cent) under section 80C.
Now consider this. An ELSS has announced a dividend of 50 per cent. The net asset value (NAV) per unit of the scheme is Rs 50. Suppose one invests Rs 1 lakh in the fund before the record date for the dividend. After the record date, the investor will get a dividend of Rs 10,000 at the rate of Rs 5 per unit for 2,000 units that have been bought. Therefore, effectively the individual invests Rs 90,000 (Rs 1,00,000 minus Rs 10,000) and saves Rs 33,990 in tax outgo.
In other words, on an investment of Rs 1,00,000 in the dividend plan of the ELSS, one gets a post-tax return of Rs 43,990 (Rs 33,990 plus Rs 10,000), or 43.99 per cent.
However, the NAV in a dividend plan declines to the extent of the dividend payout. This means that post-dividend the NAV will be Rs 45.
Traditionally, an ELSS has given dividends at a much higher rate than diversified equity schemes (non-tax saving) of mutual funds. For example, SBI Magnum Taxgain gave a 110 per cent dividend, Principal Personal Taxsaver 420 per cent, Franklin India Tax Shield 80 per cent, HDFC Long Term Advantage 60 per cent, HDFC Taxsaver 80 per cent and ICICI Pru Tax Plan 40 per cent in financial year 2007-08.
But it is seen that soon after the dividend announcement, investments in these schemes rise sharply with investors making a beeline to get the high dividends. The increase in cash flows helps the fund managers rev up investments and stem the decline in NAV.
Moreover, since one cannot redeem units in an ELSS within three years from the investment, there is no immediate rush for redemption for “dividend stripping”.
Mutual funds give high dividends under ELSS because in the absence of regular redemption pressure (as in the case of an ordinary equity scheme) the corpus of the fund grows. They distribute dividends aggressively to bring down the asset under management at moderate levels.
The dividend plans of ELSS are more beneficial than ordinary diversified equity schemes because the growth in NAV of ELSS is more.
Over the last five years, such schemes have given an annualised return of between 33 per cent and 70 per cent. On the contrary, the annual return of ordinary diversified equity schemes during the same period was between 30 per cent and 65 per cent.
The dividend income also provides some liquidity to ELSS investors. Dividend income being tax-free, investors don’t have to show this in their annual income tax return.
Instead, this payout can be reinvested every year in other mutual fund schemes, preferably in ordinary open-ended diversified equity schemes that provide more liquidity.
One can also reinvest this dividend income in a Public Provident Fund — the best option for fixed income investment.
Mutual funds generally announce dividends under their equity-linked savings schemes during the last quarter of a financial year. This is because most investors rush to make tax-saving investments during this time. Mutual funds try to attract them with lucrative dividend baits.
However, since April 2006, the Securities and Exchange Board of India has restricted mutual funds from announcing dividends in any of their schemes not more than five days before the actual payout day (record date).
Earlier, mutual funds announced the dividend payout a month in advance of the record date.
One can also invest in the dividend plan of an ELSS at the beginning of a financial year and reap the dividend at the end of the year when it is announced, while the investment grows during the intermediate months.
Invest in these Schemes for best of Safety and Returns
Well things have changed from last year in terms of stock market performance and it's right time to review which tax saving or ELSS (Equity linked saving schemes) should we invest in. Earlier, I used to analyze ELSS based on performance over a 5 year and 3 Year time frame. Though we normally look at a Three year return for determining which fund to invest in for tax saving purposes, I would suggest that we give some weightage to 1 year return also this time around. Because, this year had a good mix in terms of both sharp upside moves and sharp downside moves. we will have an idea of how the fund was able to withstand bouts of volatility. We are currently going through such a phase in the stock markets which makes us think of safety of our investments too. I have taken into account the Risk profile of each fund (based on Standard deviation) .
SBI Magnum Taxgain:
The True leader in its class, SBI Magnum Taxgain is No. 1 in our ranking. With Standard deviation of 22.13 it has managed to be second best in terms of safety of returns. In terms of performance it has beaten its nearest rival HDFC or any of the Other 4 Top picks by a big margin. With Avg. mkt. cap of above 27000 crore and with equity to debt mix of 88:12, the fund has Reliance Industries, JP Associates, Welspun Gujarat, Reliance Communications and L&T as its major holdings. The Top Three sector in which the fund has exposure are Energy, Financial Services and Diversified.
HDFC Long term Advantage Fund:
Well this chap has overshadowed its elder brother " HDFC Tax saver funds" and has emerged as the star performer from the HDFC stable. Top holdings include ICICI Bank, Reliance Industries, Blue Star, SBI and Crompton Greaves. HDFC Tax saver fund has better 5 Year, 3 year and 1 Year return than this scheme. Then why Long term Advantage fund is at No. 2? Well, in the year when investors are realizing that safety of investment is as important as the return, this fund is No: 1 in terms of risk rating. That is why this fund should stand at No. 2 in our rankings. With standard deviation of 19.84 this scheme has outperformed all the others in Top 5 by a big margin. So for those who places safety as the utmost important factor, HDFC Long term Advantage fund is the best scheme to invest.
HDFC Tax Saver
Well, this fund is second best in terms of 5 year return but scores poorly on 1 year return. Moreover, the Risk rating at 4 is the major reason for it is put in 3 slot. So new filters had a impact on its ratings.
With Avg. market capitalization of Rs. 23204 crore, the fund has top holdings in Basic Engineering, Financial Services and Energy sectors. Top 5 holdings include ICICI bank, L&T, ITC, Crompton greaves and Reliance Industries.
Franklin India Taxshield
Though this fund is slated to 5th position of our analysis, it has given a decent return and has performed with medium risk profile. It has above 35,000 crore Avg. Mkt. capitalisation and equity exposure is more than 97% of the assets. Top holdings include Reliance Industries, HDFC, L&T, ICICI Bank and Bharti Airtel. Financial Services, Technology and Energy are the top sectors where the fund is invested.
My advice would be to go for SBI Magnum tax gain for claiming tax benefits under sec. 80 C of the Income Tax Act. The fund not only provides excellent safety in terms of "Low" risk but also offers highest return on all parameters among the Top 5 schemes.
For those who want capital appreciation can go for Growth option. Those like me who are willing to get regular liquidity in form of tax free dividends, opt for Dividend Payment option.