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Why you must invest in ELSS funds

Value Research | November 28, 2005

Tax planning will soon be on everyone's mind. While the stock market already is.

Equity Linked Saving Schemes offer you a chance at both. These are mutual funds that invest in the stock market and give the tax benefit under Section 80C.

The last seven months have seen the launch of three tax-planning funds: Reliance Tax Saver, Chola Tax Saver and Kotak ELSS.

Among these, Reliance Tax Saver surprised all by collecting a whopping Rs 670 crore.

Today, tax saving schemes manage Rs 2,011 crore – thrice what they used to manage in March 2005.

Here is a good look at this investment option.

Tomorrow: Which ELSS you should invest in

The ELSS controversy

Tax planning funds have been making news since the start of this financial year. This year's Budget gave a fillip to the category by raising the investment limit in these funds for tax exemption to Rs 1,00,000.

All was going well till recently when the government issued a notification stating that the ELSS would have to be a close-ended fund (funds with a specific date for closure) with a maturity period of 10 years.

However, this was soon taken care of and all tax planning funds have been declared eligible for tax exemption under Section 80C of the Income Tax Act.

The returns are great

Tax planning funds have exploited the rally in equity markets very well.

In the three-year period ending November 10, 2005, they were the best performing mutual fund category with a return of nearly 60%.

Funds like Magnum Taxgain, HDFC Taxsaver and Prudential ICICI Tax Plan have generated sensational returns – all of them appreciated by more than 80% during this three-year period.

In 2003, on an average, these tax planning funds gave a return of 108.97% while the Sensex rose just 72.89%. Birla Equity Plan rose as much as 160.95%.

In 2004, the Sensex gained just 13.08% while on the average, tax planning funds gained a little over 30%. Magnum Taxgain delivered a 53.93% return.

Over to 2005. Since the start of the year till November 10, the Sensex rose 28.3% while tax saving funds delivered a 35.16%.

The ones delivering the best return were Magnum Taxgain (76.21%), HDFC Taxsaver (57.35%) and Prudential ICICI Tax Plan (51.18%). 

The tax benefit

The limit under Section 80C is Rs 1,00,000. This is irrespective of how much you are earn and under which tax bracket you fall.

If you choose, you can invest the entire amount in ELSS. 

Let's say your taxable income is Rs 100,000. You invest Rs 70,000 in ELSS. Your taxable income drops to Rs 30,000 (Rs 100,000 - Rs 70,000).

Where they are investing their money

Over the last two years, these funds have shifted their focus from large-caps to mid-caps. This year, a majority of them began investing substantial amounts in small-cap stocks.

Today, more than half of the funds in the category have mid-cap dominated portfolios (total investments).

Funds like Libra Taxshield 96 and Canequity Taxsaver had more than half of their assets (money available for investment) invested in small-cap stocks in October 2005.

Technology stocks are still the favourite with financial services stocks gaining in popularity followed by basic engineering, consumer durable and non-durable stocks.

Healthcare, metal, chemical, services and energy stocks have dropped in preference.

Before you invest

Investing in such funds is no easy task. There are 24 such schemes to choose from. Unlike the Public Provident Fund or the National Savings Certificate, the returns here are not guaranteed.

Returns from equity depend on the stock market and are very volatile. While there is a chance at earning handsome returns, the likelihood of incurring losses is also high.

Decide what part of the Rs 1,00,000 (limit under Section 80C) should be invested in ELSS.

The younger you are, the greater the amounts you can think of investing in these schemes.

Also, unlike PPF and NSC where investing at one go does not have any impact on the investment, lump-sum investing in an equity fund could be dangerous. Because you may end up investing when the market is at the peak of the bull run.

Decide how much you want to invest in an ELSS and start investing a fixed amount right away every month (you still have four months from December to March).

This periodic investing is referred to as a Systematic Investment Plan.

Let's say that every month, you commit to investing, say, Rs 2,000 in your fund. At the end of four months (end of this financial year), you would have invested Rs 8,000 in your fund.

Let's say the NAV on the day you invest in the first month is Rs 20; you will get 100 units.

The next month, the NAV is Rs 25. You will get 80 units.

The following month, the NAV is Rs 18. You will get 111.11 units.

So, after three months, you would have 291.11 units. On an average, you would have paid around Rs 20.61 per unit. This is because, when the NAV is high, you get fewer units per Rs 2,000. When the NAV falls, you get more units per Rs 2,000.

Tomorrow: Which ELSS you should invest in

Value Research

 

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