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Are You Investing In Funds To Save Income Tax?

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By Author: VVK Prasad Vivekam
Total Articles: 17
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Income tax prompts most people to invest in financial instruments. Equity Linked Savings Schemes offered by Mutual funds are preferred by salaried class as a means to save tax as well as earn decent return on their investments. Though Insurance policies, ULIPs, repayment of house loans, provident fund contributions etc also qualify for tax exemption, many salaried people prefer mutual funds.

9 out of 10 investors in this class make up their mind speaking to friends or other ill-informed people. Mutual fund advisors also are happy to suggest a fund that has returned highest return, as on today, among its peers as an ideal choice.

Most websites are also content with providing such details. It would be wise to buy a fund that has been consistent in returns than a fund which might have turned in better performance in period that ended with current day.

Vivekam believes and advocates that a choice of ELSS fund should consider the following. In fact, even if your investment is not in ELSS, the following factors are very important and cannot be ignored.

1. Consistency: Check whether a particular fund has ...
... given higher return in all comparable three year periods, not a single three year period ending today. For example there could be various three year periods possible in the fund like.. Jan 1, 2003 – Dec 31, 2005; Jan 2, 2003 – Jan 1, 2006; Jan 3, 2005 – Jan 2, 2008; Dec 12, 2007 – Dec 11, 2010 etc. Only if the fund has earned high returns in majority of those periods, the fund should be called investment worthy.

2. Negative returns: We must also pay special attention to instances where the fund returned losses. Suppose if the index has reported losses in 250 instances out of possible 1,200 three year periods and fund reported losses in 300 instances in the same 1,200 cases, the fund is better avoided. Such aggressive funds are highly volatile and when we need money it could be giving us negative returns.

3. Less than Bank interest: One should also check the number of instances when the fund gave lower income than banks. Stay away from funds that fail to generate higher returns than banks. If you are investing for tax saving, you must realize that investing in bank fixed deposits also offers exemption. Instead of going to mutual funds where the returns are not sure, you may as well put money in bank where safety is assured.

4. Beating market returns: If your fund has earned better returns because of favorable market, it cannot be deemed as better one. To determine the suitability of fund for your investment, you should compare the return of your fund with index in the same periods. The more periods you can check, the better your assessment will be. If index has turned better returns than fund in more number of cases, you may move away from this fund. Fund earning 40% when index rose by 50% or a fund losing 15% when index lost 10% cannot be called a good fund, notwithstanding the performance in latest period.

5. Your friend may not be ideal reference: Stock markets and mutual funds are believed to be running on democratic principles where collective wisdom of millions of participants determines the relative success or failure of one’s investment decisions. Every one will have equal chances to lose or gain. If your friend ever said that he benefited by investing his sum in a particular fund, you must check whether his luck helped him get into that fund at the right time, but not necessary the right fund. As explained in point 1, you must check the average returns across different periods and should never allow yourself be blinded by point to point returns.

To be prudent, instead of incurring losses in your investment by choosing a wrong fund for tax saving, you should make an effort to spot the right fund. Else, you may be deeply disappointed with fund although you saved some tax in bargain. Let us examine some mutual funds meant to save tax and are in existence for at least 10 years.

Franklin Tax Shield:

This fund has been in the market for a long time. For our analysis we collected the data from 2003 and noticed that it was around for more than 2000 trading days. In other words there could have been more than 1700 cases of different three year periods viz., Day 1 – Day 300, Day 2 – Day 301, 100 – 399, 754 – 1053 etc. There could have been over 2,200 cases of 1 year too.

Comparison with Index – Area A

When we compared the performance of this fund with index over 1 year, as shown in area marked “A” in the picture, you will notice that index did better in 25% cases. Only when we held it for over 5 years its performance improved. It is bad for people investing for periods of less than 5 years.

Comparison with Banks – Area B

Though this is a tax saving scheme, its performance in three year period was not great because banks have given higher returns than this fund in 15% cases. While beating banks in 85% cases is Ok, it is still not the best for you to invest.

Negative returns – Area C

We all know that investments in stock markets are subject to overall sentiment and it is tough to be a winner at all times. However, when we compared this fund with index on losses, in three year period, it returned losses in 95 cases as against index’s 104. Being not able to beat index 95% times does not speak well about this fund. It cannot be termed as worse fund but cannot be called better even. Hence it is just a OK fund and therefore classified as Moderate for 1 to 4 year time frames. It can be called good fund only if one wants to invest with 5 year time frame.

Comparison with Alternative investment channels – Area D

We also compared the returns from Vivekam’s BIO-Secure and BIO-Growth strategies for the same periods. Both the products have done better than this fund in three year period (any three year period in last 10 years) in 85% and 88% cases respectively. When it comes to 4 or 5 year time frames BIO products were far ahead of this fund.

Finally, we also compared the average returns earned by index, Franklin Tax Shield, BIO-Secure and BIO-Growth to let you know the relative positioning of this fund as of today by taking all data from 2003 into account.

By becoming a member at Vivekam, you will have an opportunity to check the relative strength or weakness of most of the mutual funds in fraction of seconds.

Wish you happy investing…

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