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While past performance does not guarantee future returns, you can see that
the ELSS lock-in rule (though it may seem like bitter medicine at the start of
the investment period) has provided the impetus for out-performance.
PPF, NSC, KVP and Infrastructure bonds earn a fixed rate of interest
every year (or every six months, as the case may be), Many of these options
are considered ‘safe’. Since they are backed by the government or by
established
banks and financial institutions. However, none of these instruments are safe
from inflation! PPF currently provides 8% a year, NSCs fetch you a return of
around 8% a year (interest earned is subject to tax), and infrastructure bonds
return about 5-6% a year (again, subject to taxes). With inflation currently
ranging between 4-6% every year, real returns on these investments may not
be very high.
While fixed rate savings and insurance are useful in their own right and
should be part of a well-balanced portfolio, if you are looking for tax benefits
coupled portfolio, if you are looking for tax benefits coupled with the earning
potential of equities, then consider an ELSS.
Risk and return: Such schemes carry the same risk as equity diversified
schemes. Yet they could deliver better returns since the lock in period gives
the scheme’s fund manager the freedom to invest without fear of redemption
pressures.
Suitability: These schemes are suitable for investors who are looking for a
tax break from their mutual fund investment and can safely lock away their
funds for a period of three years.
Saving on a regular basis in this way is easy as you treat your investment as
part of your monthly budget. What’s more, you can benefit no matter how the
markets are performing:
The regular saver finishes the period with a investment that is worth more
than that of the lump-sum investor-even though the starting price, finishing
price and average price are exactly the same. It sounds unlikely, but it’s true.
Check the figures for yourself!
• If the market goes up, the units you already own will increase in value.
• If the market goes down, your next payment will buy more units.
Hence the 3-year period should be treated as the minimum time frame for
evaluating the performance of a tax-saving fund (as also all other equity
investments).
While evaluating performance, it is important to note how the fund has fared
over varying time periods. Every equity fund has its day under the sun during
a bull run; it's the bear phase that separates the experts from the punters.
So your view on a tax-saving fund should not be based on its performance on
the last rally, it should be dictated based on its performance on the last market
downturn.
4. Compare performance on the risk parameters
The NAV performance is not the only parameter to be considered for
evaluation in your quest for a well-managed tax-saving fund. Parameters like
Standard Deviation and Sharpe Ratio must be given equal weightage.
How often have we seen a diversified equity fund deliver a brilliant
performance on the 'NAV return' parameter by sacrificing all the rules of
prudent investing and making aggressive investments across stocks and
sectors and apportioning an above-average allocation to high risk investments
like mid cap stocks or technology stocks for instance.
Therefore it's important for investors to keep an eye on the risk that the fund
has taken to deliver that high-voltage performance. Risk parameters like
Standard Deviation and Sharpe Ratio are important indicators.
Standard Deviation measures the degree of volatility that a fund exposes its
investors to. Similarly, Sharpe Ratio is used to measure the returns delivered
per unit of risk borne.
The ideal combination for an equity/tax-saving fund is lower Standard
Deviation (i.e. lower volatility) and higher Sharpe Ratio (i.e. higher return vis
the risk-free investment).
Pension schemes – are also allowed the same tax break that is applicable to
ELSS, i.e., an investor can claim a deduction from taxable income for
payments made to specified pension plans, up to a limit of Rs.1 lakh under
Section 80C of the Income Tax Act. These funds aim to build up a corpus for
investors that can be converted into an annuity on retirement. This annuity
will ensure that the investor receives a regular stream of income post
retirement.
Risk and return: These schemes invest most of their funds in conservative
instruments since capital preservation is their prime objective. Accordingly,
the risk exposure of such funds is minimal.
Suitability: Such schemes are ideal for individuals who are currently in a
high tax bracket due to the magnitude of their current income but expect to
witness a drastic fall in income post retirement.
Such individuals can avail of the dual benefit of a tax break at present along
with the comfort that they are saving for their post-retirement years.