Tag: mutual funds

Saving Tax The Smart Way

You start your financial year (in April every year) by investing in some SIPs. In case your objective is to save tax, you start investing in a Tax Saving fund (refer Mutual Funds to know more). Is there a better way, a new way to do it? There sure is; consider what follows.

Instead of investing money into a tax saving fund (ELSS or whatever), let’s invest our money in some other great fund. We’re looking at doing a small time investment, so choose the fund that has been doing great in the last two years (smaller period shows the popularity of the fund in recent times, though not necessary). So let’s say, we have a top ranking fund called A Company Fund. We choose two other funds (in all 3 funds), B Company and C Company funds (note that all of these funds should be Open Ended). Now let’s break up a monthly investment of, say Rs. 10000 into 3, make a round figure of 3500 each and invest into SIP of these funds from April to December (for 9 months).

Come December, let’s switch in all the investments done in Company A Fund to a Company A Tax Saver fund, Company B fund to Company B Tax Saver and Company C Fund to Company C Tax Saver fund.

Here’s a point-by-point break-up of the same thing:

  • Let’s say, you have a tax investment objective of Rs. 50000 from Mutual Funds (assuming rest of you investments are done elsewhere).
  • April: Start SIP of 1800 in Company A Fund (a top ranking fund from Company A) for next 9 months (till Dec)
  • April: Start SIP of 1800 in Company B Fund … for next 9 months (till Dec)
  • April: Start SIP of 1800 in Company C Fund … for next 9 months …
  • May: SIP for Companies A, B and C Funds for 1800 each (total 5400 this month).
  • June-November: SIPs repeat until December.
  • December: Your last SIPs of 1800 each get deducted in Company A, B and C funds.
    • Investments in each of Co. A = 16,200 + Co. B = 16,200 + Co. C = 16,200
    • Total investment till December: 5400 x 9 = 48,600
  • Now, you switch in your individual investments from Co. A, B and C to Tax Saver Funds (of the same companies) including the profits you got.
  • Let’s imagine if…
    • ..Co. A performed with a profit of 20% – you get back Co. A Tax Saver funds worth 19,440
    • ..Co. B performed with a profit of 15% – you get back Co. B Tax Saver funds worth 18,630
    • ..Co. C performed with a loss of 10% – you get back Co. C Tax Saver funds worth 14,580
    • Your total tax investment for this year would be: 19,440 + 18,630 + 14,580 = 52,650
    • Magic right? You exceeded the tax investment objective you had set even after investing a lesser amount.
  • Now you have to pay back some capital gains: Co. A = 648 + Co. B = 486 Co. C = 324 = 810
  • Just pay back some tax of ~ 800 (capital gains tax calculated with 20%, a good tax return preparer can bring it down further).
  • Including the capital tax gains you paid back, the money you paid for the whole thing was: 48,600 + 810 = 49,410
  • And your investment was done for: 52,650 – you saved an investment of 3240.

Those figures don’t impress you, do they? Then, what else is the advantage of doing things this way?

  • Your tax savings are done all at once in January.
    • This means, after three years, you can draw the whole amount out all at once. When you do an SIP on tax saving, you have to wait month by month for withdrawal.
  • The profits you get out of the earlier investments act as a buffer and take care of any market fluctuations at the time of your Tax Investments.
  • Also, although you pay tax (10% or 20%) on these profits, you actually get the one lac limit benefit on the same money too.
    • Thus you achieve your one lakh goal by investing a lower amount of money through the year.

No really, there should be some disadvantages too? God save you…

  • …if the capital tax gains are increased (from 10% or 20%).
  • …if you run into losses in all the top 3 funds you chose from Co. A, B and C.
  • …if the Tax-Saver funds for the three companies A, B and C somehow stop accepting fresh investments.

But all of the above are circumstances beyond control. And that is where you step in with the word – risk.

So go ahead, and at your risk, try investing in the way above (repeating: try all this at your risk).

Mutual Funds – Saving Tax

Mutual funds explained with some comment on how to save tax.

  • ELSS = Tax Saver (Saving) Mutual Funds (Schemes)
  • You can invest upto one lakh in any ELSS scheme.
    • You should check if you really need to invest one lakh, because in all probability, your employer is already deducting PF from your salary.
    • In that case, your investments should be: 1 Lakh – (monthly PF deduction x 12)
    • PF = Provident Fund = Govt’s way of making people save from their salary.
  • This investment gets locked for 3 years (lock in period = 3 years).
    • That means that if you invest Rs. 3000 today, you will get it back only after three years from today.
    • That also means that if your are doing an SIP of Rs. 3000 every month, the three years are counted for every 3000 from the month they were invested.
    • SIP= Systematic Investment Plan = Fund’s way of saying “please invest in us regularly at a definite interval”.
  • Lock in period of 3 years is good, why?
    • …because that ensures that people can’t take out money for at least next 3 years.
    • … and that makes it easy for the funds to make more money for you.
    • … also this is better than locking your money away for 5 or 7 years (in other schemes – don’t worry about them if you don’t know).
  • Which fund to choose?
    • Choose a fund (search now: http://search.yahoo.com/search?p=elss+funds) that has:
      • a decent asset size and
      • and good two years performance (look at the rate of return in the last two years)
    • Frankly, every fund company has two or three Tax funds (or may be just one)
    • It’s better to keep your folios tight and invest in a Tax fund of the company where you already have funds
      • Reason: tax funds generally are better than any other tax saver investment, so you should really not worry about choosing, too much.
  • Which option to choose?
    • Choose growth option. Don’t choose dividend re-investment. That’s because you really don’t want any more money to get locked again for three years.
      • So if you choose dividend re-investment, and the fund declares a dividend of Rs. 500 at the 29th month after your investment, that Rs. 500 per unit will get locked for three more years.
      • In effect, you will get back the re-invested money after another 36 months (in case the Govt. keeps lock-in as 3 years).
      • So, you get back the dividend money after 29+36 months of your original investment.
    • Options: Growth – this means that you won’t get any dividends, but your fund’s NAV will increase intrinsically with dividend declarations.
    • Options: Dividend Payout – this means that a dividend declaration will give you back cash in your account. Some times this makes sense.
    • Options: Dividend Re-investment – Any declaration will buy you new funds for whatever money you might have got paid. Stay clear of this one.
    • NAV: Net Asset Value – Fund’s way of saying “my one unit will cost you this (NAV) much.”
  • The best way to invest is using an SIP.
    • During April, calculate what your PF amount is (assuming your appraisal and stuff is over).
    • Multiply that by 12 and then deduct it from one lakh. There you go, you have an investment figure – X.
    • Divide X by 12, and decrease another figure Y from this new Z = X / 12.
      • This Y depends on your age. Y is directly proportional to [Your Age – 28].
      • Y is the money you should invest in a fixed return investment (like Fixed Deposit, National Saving Certificates or Public Provident Fund).
      • Y is totally your call, but should be quite less than Z.
    • Your total fixed return investment becomes Y x 12, and ELSS investment is (Z – Y) x 12.
    • Your SIP should be for an amount of (Z – Y), starting in April.