Investing in mutual funds: keep the tax factor

Mutual fund investments have become a hot spot among young investors capitalizing on the tool as a long-term savings option with comparatively good returns combined with tax-saving benefits. They don’t care about the risk factor attached to the good returns promised by investment funds if it’s tax saving tools. But should you consider tax-saving mutual funds or share-linked mutual funds (ELSS) as an investment option or keep the two separate?

Experts believe that taxes are only secondary and should not be the basic criteria while you are in the market for a good fund for your savings. The vital factor in choosing a mutual fund is whether the fund category is suitable for your financial goals.

ELSS or tax saving mutual fund investing is a beneficial way to save taxes under 80C of the Income Tax Act. Over the years, investing in ELSS has generated an annualized return of more than 14 percent over the last 10 years and allows you to show an investment tax return of up to $1.5 lakh These are pure equity funds and quite similar to flexible cap funds in their investment mandate. At ELSS, a fund manager has the flexibility to invest in companies of different sizes and sectors in any proportion. But the benefits of ELSS come with an additional clause.

Investment in ELSS has a mandatory lock-in period of three years. So even if you are making a monthly systematic investment plan (SIP) or a lump sum investment for tax saving purposes, you will not be able to redeem the amount invested for the next 3 years. For example, if you had invested $5,000 per month through a SIP in May 2019, the three years for the first SIP installment will be completed in May 2022, for the second in June 2022, for the third in July 2022 and so on. So, if you don’t want to forget about the money you save each year and return to seek returns only after 8-10 years, you’ll be a happy investor, but if you’re looking to redeem the amount invested in phases to meet short-term goals, then ELSS is not what you should consider. In such a scenario, you can opt for a flexible capitalization fund that would be free to redeem your money in an emergency or if something goes wrong with the fund.

You should also consider paying taxes on your investment earnings when deciding on your mutual fund strategy. Previously, if you redeemed your mutual funds after a year, you would not have attracted any tax, whereas now you may be required to pay 10 per cent tax on any gains over 1 lakh. So to avoid taxes and save yourself from market volatility, long-term stock mutual funds are the best option for you.

However, for a medium-term horizon, you can opt for a mix of equities and fixed income where the investment ratio would depend on several factors: whether the target is tradable, how much risk you are willing to take, etc. If the target is tradable, you can have a higher allocation to equities, otherwise have a higher holding in fixed income. A non-equity fund’s capital gains after three years are taxed at 20 percent after providing the benefit of indexing. If sold within three years, the gains are added to your income and taxed on the appropriate slab.

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