Deductions under 80C: ELSS Mutual Funds

This is part 3 of the series about Tax Savings and I will be explaining in detail about one of my favourite tax savings investment – ELSS Funds. Click here for the previous parts about tax slabs and Life Insurance.

ELSS Funds

ELSS stands for Equity Linked Savings Scheme and it is just a fancy name for a equity mutual fund which has a lock-in period of 3 years and investments under which you can claim tax savings under 80C.

Now that is a lot to take in that previous line – lets break it down.

Equity Mutual Fund: You invest your money along with thousands of others to collect a huge corpus of fund. There is a dedicated professional who handles all your money and invests it in different stocks/bonds. He is called the Fund Manager. For this he charges a small percentage per year as fund management fees (also called expense ratio). Equity Mutual Funds are the most efficient investments which can also beat inflation.

Lock-In period: Any normal equity fund doesn’t have any lock-in period. Which means you can put your money today and choose to take it out in a few days. There might be some charge, but your money isn’t locked in.

But ELSS mutual funds have a lock-in period of 3 years. If you invest your money on Jan 1 of 2017, you will be able to take it out only on Jan 2 of 2020. Having a lock-in makes sure that you are invested for the long time which is very important for equity funds.

Usually all tax savings investments have a lock-in period. ELSS funds has the shorted lock-in period of 3 years.

Tax Savings under 80C: Investment made in ELSS funds are eligible for tax deductions under section 80C. You can invest any amount in ELSS funds, but a maximum of Rs.1.5 lakhs will be eligible for 80C deduction.

So how does one invest in ELSS funds?

There are numerous fund houses which has a tax saver or ELSS fund. You have to first identify a fund which is good. Since your money is locked in for 3 years, choosing a good fund is important.

There are numerous websites which list mutual funds and one website that I use is Value Research Online. Go there and select all ELSS funds available and go through each of them. See how well it has performed over the past years.

  • Has the fund manager consistently beaten the benchmark?
  • How many years has the fund manager been managing the fund?
  • Is the expense ratio small enough?
  • You can also look at the portfolio of the fund to see if the companies it has invested in are diverse enough and well performing companies.

Always do SIP

Once you decide which fund to invest in (pick only one) start an SIP on the fund. Most mutual funds allow investing directly online through their website. If not, you would have to download and fill up the form and write out a cheque for the amount and send it to one of the investor centres.

It is important to start a monthly SIP so that your investment isn’t affected by the volatility of the market. Whether the market is up or down, you keep investing in it and let the investment take its own time to bear fruits.

Though ELSS are my favourite of the tax savings investments, it isn’t the only place where I invest. There are also other instruments which would be a good fit for your risk taking abilities. In the next part I will explain about those.

Last minute tax savings investments

Mar 31 CalendarIf you are a salaried employee the next 1 month is when your company’s HR/Payroll department keeps bugging you for your tax savings. And many employees haven’t done any investments for tax savings for this year or haven’t completely maxed out your 80C. If you also belong to that camp, there would be some colleague or friend who would try to sell you some LIC policy or a ULIP policy. But you know that you handling your insurance and investment yourself will lead to much better returns than buying an ULIP at the last moment.

If you checked my previous article comparing ULIP vs ELSS mutual funds you see that I suggest taking a term insurance and then doing a monthly SIP into a ELSS fund. Doing a monthly SIP would protect you against the ups and downs of the market. But since you missed your opportunity to start your SIP at the beginning of the financial year, you are now stuck with buying your fund at a lump sum amount. If the markets fall down after you just bought your fund, you will be at a significant loss. But there is a solution to that too.

I am assuming that you have not done any of your 80C investments and you have 1.5 lakhs ready to be invested. If you are contributing to an EPF (Employees Provident Fund) then subtract that total amount for this year from 1.5 lakhs and likewise subtract any life insurance premium you have paid.

Step 1: Get a Term Insurance first

If you don’t have a life insurance yet and you have others who are financially dependent on you, you need a term insurance first. There are numerous websites where you can search and compare different term insurances. Two of the popular ones are Policy Bazaar and the new CoverFox. First decide on a sum assured value which needs to be at least 10-12 times your current annual income. So if your annual salary is 10 lakh, your cover should be 1.2 to 1.5 crores.

Choose whichever policy is lowest price and has a decent claim settlement ratio. You won’t need any of the fancy riders or add-ons to your policy. Buy your policy online and you will be asked numerous questions. Please fill it in accurately. You would also be asked to do a health checkup (which is mostly to detect if you are a smoker or not). After all those are done, your policy document will be emailed and also sent by post to you. Now your insurance is done so you can subtract the amount you paid as premium from the 80C 1.5 lakhs limit.

Step 2: Put remaining money into ELSS

Next is investing into an ELSS fund. There are numerous ELSS funds and it is difficult to choose a good ELSS fund these days. You should get a professional financial advisors help if you can’t choose one yourself. But if you can spend a few hours you can identify good funds yourself. Goto websites like ValueResearchOnline and search for a section called ELSS. It would have different funds that are sorted by star rating. Just ignore the star rating.

Instead check for funds which has consistently performed well and given good returns even if the market is not doing good. Those fund managers know how to really pick the right stocks to invest in even if the market is on a downtrend. You can also check what kind of companies that fund invests in and how it has performed over the past 5 years. There are also neat graphs to show how an SIP in that fund would have performed.

Now we unfortunately can’t do an SIP today as we don’t have enough months remaining in the financial calendar. But we have enough weeks remaining – and as of Monday (Jan 30), exactly 9 weeks to March 31. Lets assume that you have to invest 1.4 lakhs into ELSS dividing it by 9 weeks, you have to invest Rs.15,555 per week into the fund.

Weekly SIP
Invest your weekly amounts on the dates marked in red

I can hear you asking that there is no SIP option for weekly period.
Yes there isn’t.
Does it mean you have to login to your mutual fund website and manually invest in the fund every week?
You can do that, but No. There is an easier way.

For this week, invest the first week’s amount manually. Then in the same fund house choose a Liquid fund. Make sure that the fund has no exit charges. Put your entire money into that Liquid Fund and search for an option called STP and set it up to transfer the weekly amount from the Liquid Fund into the ELSS fund on a specific day of the week.

STP to the Rescue

STP means Systematic Transfer Plan. It is an easy way to transfer money from one fund into a different fund within the same fund house. STP allows you to transfer money weekly, fortnightly, monthly or quarterly. Once you have set it up, transfers money from the Liquid Fund into the ELSS fund (just like you would have done a monthly SIP from your bank account to the ELSS fund).

And since you are doing a weekly transfer, even if the markets fall after week 1 or 2, you will be able to capture the fall over the next weeks. And the best part is once you have set it up, you wouldn’t have to lift a finger as everything is automated. End of the March you would have invested all your 80C money into an instrument which is both tax efficient and also have protected it against the market volatility.

Don’t forget to setup an SIP per month for the right amount from April 2017 to Mar 2018 (or till any year you want to).

Remember to use this STP only if you haven’t done your full 80C savings this year. Doing your regular 80C investment via STP instead of SIP would also work, but if you forgot to put in the money in your Liquid fund your STP would stop and you wouldn’t remember to check it. Instead go for a simpler SIP as the difference between a monthly vs weekly investment wouldn’t be too much over the long run.

At least from the next financial year onwards be more regular in your investments and make sure you don’t get stuck with a bad investment at the last minute. If you have any other ideas on savings tax better with only 2 months remaining, please comment below.

PS: This is just a simple idea for people to invest at the last minute. Each person’s financial situation might be different. Please get in touch with your financial advisor (you do have one right?) or email me at srini@getricher.in for help.

Common Misconceptions about Mutual Funds

Mutual Funds are an easy way to invest your money and let professional fund managers handle the hard part of choosing the right place to put your money in. But there are numerous confusions and misconceptions around mutual funds that I want to clear in this article.

Myth: Mutual Funds is just for equities

Fact: Mutual Funds are not only about investing in stocks or the equity market. There are different types of funds which are classified based on the underlying asset classes they invest in.

  • Equity Mutual Funds – invest mostly in equities (note mostly. SEBI says minimum it should have 65% in equity)
  • Debt Mutual Funds – invest mostly in debt or fixed income
  • Liquid Funds – invest in very short term (< 91 days) instruments like treasury bills.
  • Gold Funds – they invest in gold and track the price of gold.
  • International Funds – they invest in stocks of international companies and track foreign stock indices like Nasdaq.

People who want to invest in any kind of assets can invest using Mutual Funds and get the help of professional fund managers to handle their money.

Myth: A mutual fund with lower NAV (Net Asset Value) is cheaper and better

Fact: A fund’s NAV doesn’t matter because it represents the market value of all the fund’s investments and doesn’t depict the market price.

To understand it better: Lets say Fund A and B invests in the same portfolio of stocks. Only difference between then is the NAV of fund A is Rs.10 and fund B is Rs.100. After a year the stocks increase in value by 10%. So the NAV of fund A will be Rs.11 and of fund B will be Rs.110.

NAV of two funds

So your money grows by 10% and it doesn’t depend whether you invest in fund A or B.

Myth: Mutual funds are long term investments only

Fact: There are mutual funds which are suitable for short term investments too. They are funds which invest in bonds or even treasury bills which are protected for returns for a short duration. If you are in the highest tax bracket parking your excess money in Liquid funds or ultra short term funds are better and tax efficient than fixed deposits.

Myth: One needs lot of money to invest in Mutual Funds

Fact: No. You can invest in mutual funds even if you have just Rs.1000. And you can start an SIP even with Rs.500/month. Compared to investing in real estate or Gold, this is one of the best investments which doesn’t require lot of money.

Myth: Any investment in mutual funds enjoys tax benefits

Fact: Only ELSS (Equity Linked Savings Scheme) funds enjoy tax benefits under section 80C. And they too have a limit of Rs.1.5 lakhs per year. Remember any investment made in ELSS are locked in for 3 years.

Myth: Invest in lot of funds to properly diversify

Fact: Investing in lot of funds doesn’t help. Remember a fund just a collection of different stocks that a fund manager chose to invest in. Most of the funds would have a lot of overlap in the stocks. Also over diversification also hurts your returns. It is better to invest in only 1 good fund under each fund type.

Multiple funds

I personally am invested in 1 ELSS, 1 Large Cap, 1 Mid Cap and 1 Small Cap fund. There is no use in investing in 3 or 4 funds under each category.

I hope this has cleared some common myths surrounding mutual funds. Now the only problem is how to choose the right fund and how to invest in it the right way. Will cover it in future articles.