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Taxation Benefit with Mutual Funds

There are various categories of mutual funds -equity-oriented, debt-oriented, hybrid, thematic etc. and each of these have a sub-category that address to a set of investment objectives or needs.

At the time of investing, if you are looking for investment up to Rs 1.5 lakh to save Tax under Section 80C of the Income Tax Act, 1961, Equity Linked Savings Scheme (ELSS) is the answer.

It’s not easy to watch your hard earned savings simply getting deducted in taxes. So, with the beginning of the new financial year, we’re giving you a quick run through about how you can save your hard earned money by investing in a Tax Saving (ELSS) scheme.

An ELSS (Equity Linked Saving Scheme) could become your best choice if you’re looking for:

Deductions under section 80C of the Income Tax Act, 1961
Opportunity to invest in the equity markets
Long term Capital appreciation
Shortest lock-in period of all the tax saving instruments under Section 80C

ELSS is an open-ended equity-oriented mutual fund scheme that invests a minimum 80% of its assets in equity & equity related instruments.

The investment objective of an ELSS, broadly, is to build on your investment corpus by investing primarily in equity and equity-related instruments. A unique feature about ELSS is that compared to the other open-ended diversified equity mutual funds, investment in ELSS is subject to a compulsory lock-in period of three years. During this period, you cannot redeem your investments before the completion of three years from the date of the investment

Understand taxation in mutual fund

Income from sale of ELSS and other equity mutual funds are called as capital gains. This income is taxable in the hands of investors. The tax to be paid on the capital gains depends on the time period for which the investment was held. The minimum holding period for long term capital gains in equity funds is one year. Gains made on an investment in equity mutual fund sold before completion of 12 months from the date of purchase is termed as short term capital gains. Gains on any investment held over 12 months is long term capital gains.

Short term capital gains (if the units are sold before one year) in equity funds are taxed at the rate of 15% plus 4% cess. Long term capital gains tax in equity funds is 10% + 4% cess provided the gain in a financial year is over Rs 1 Lakh. Long term capital gains upto Rs 1 Lakh is totally tax free. *

When it comes to ELSS after the lock-in period of three years, long term capital gains (LTCG) tax on mutual fund redemption applies, as per the current tax rules.

Whereas when it comes to debt mutual funds, short term capital gains tax is applicable as per the investor’s Income tax slab rates for a period less than three years whereas the rate of long-term capital gains tax for period exceeding three years is 20 percent with indexation benefit.

For those investors looking at an option to save tax, and earn risk adjusted returns from your investments, could consider adding ELSS mutual fund to your portfolio. The simplest thing to do would be to invest in an ELSS fund, which helps you build wealth and save tax. Remember, though saving tax liability is a major purpose behind investment in tax saving fund; any investment should also deliver some return. Hence, while evaluating your options for the best fund to invest in, you need to look at the return column too. Do not forget that as an investor, you should know the risk and reward attached to investment before taking the plunge with your hard earning money.

A famous American Wealth Manager, Barry Ritholtz once said “When it comes to investing, there is no such thing as a one-size-fits-all portfolio.” Therefore, personalization is important when you construct a mutual fund portfolio. Save tax conveniently by investing in ELSS Mutual Fund.

What is the difference between direct & regular mutual funds?

When it comes to investing in Mutual Funds you generally have two options; Regular plan & Direct plan. If you invest via distributor you get a regular plan & if you invest via RIA’s or Directly in Mutual Fund Schemes you get a direct plan.

A regular plan differs from direct plan in terms of the cost structure. The cost associated with regular plan translates into a higher expense ratio which includes the income earned by the distributor in the form of distribution or transaction fees. This added cost which is passed on to the investors who invest via regular plan. Hence, as the expense ratio in a direct plan is lower, it has a higher NAV as compared to regular plans.

Salient Features

How to Switch:
While the process depends on the respective AMC’s website, as a standard, switch option can be conducted online or in person by visiting the nearest branch If you are not comfortable with the online switching procedure, then you can also switch funds offline. To switch offline or in person you will need to visit the nearest branch of the fund house and fill and submit a switch form. Once they process it, they will send you an updated account statement. You can also get this done via your distributor.

Net Asset Value (NAV):
The TER (Total Expense Ratio) of any mutual fund plan is adjusted from the NAV. The NAVs of direct plans are higher than the regular plans since TERs of regular plans are higher than those of direct plans. In other words, the investment value after you make an investment will generally be higher in a direct plan compared to a regular plan.

Returns:
The difference of TER between regular & direct plans varies from one AMC to another and scheme to scheme, largely depending upon the commission structure of AMCs. The commissions or brokerage paid for equity funds are generally higher than debt funds. The difference in TERs between regular & direct plans can range from 0.5% to 1%. Although this sounds minuscule, it directly affects the returns of regular and direct plans. When you are investing for a long term and you compare returns of mutual fund direct vs regular plans, the direct plans can add up to big amount of difference in returns on your investment.

Direct plans have lesser costs and give higher returns over regular plans. However, you need to have some investment experience and knowledge to pick and invest in the right direct mutual fund plans.

Whenever you are making a switch from a regular plan to a direct plan or vice versa, always remember that switching of funds means selling your current units and purchasing units under the new scheme. While switching, there may be certain exit loads applicable. You also need to consider the tax implications. Hence, be wise when making a switch decision. Consider and reflect on your overall financial goals before making any decision.

How to select mutual funds beyond star ratings

Why should you not only depend on ‘Mutual Fund Ratings’?

It is essential to look beyond rating for various types of mutual fund schemes. Investors need to consider the following factors:
Evaluate the financial health: An investor must thoroughly perform due diligence on his investment’s financial health
2) Portfolio composition: Investors also need to check the portfolio components, sector allocation, the credibility of government papers in different types of mutual funds he is looking to invest.

3) Cash level: Fund Managers adjust the cash level in their portfolio depending on the prevailing liquidity requirements and portfolio changes due to market cycles. If the equity markets are rising, they trim their respective allocations to keep a higher portion in cash and reduce the cash level during a falling market. Therefore, it is advisable not to blindly follow star ratings for various types of mutual fund schemes.

It is not wise to judge several types of mutual fund schemes based on star ratings, as they can also be subject to market risks. . Always remember high returns and high risk goes hand in hand.
In a nutshell – Yes, one can consider ratings for different types of mutual fund schemes to reduce the time on research, but this should not be one of the most important factors to consider while choosing a mutual fund.
Here are six factors to consider when choosing different types of mutual funds schemes in India beyond the best star rating funds

Goals – While investing in a mutual fund or several other types of mutual fund schemes, one must choose its goals in terms of the time period, returns and primarily the specific goals. For example, planning your retirement, planning a vacation or buying your dream house. It is imperative to identify each goal depending on various factors such as age, income, gender, etc. You can take a call depending on the tenure, be it long or short term, and select the types of mutual fund schemes accordingly.
Risk – Risk is an important factor to consider while choosing the types of mutual fund schemes offered by mutual fund Companies as risk is a phenomenon of uncertainty. Do consider your risk profile before opting for various types of mutual fund schemes like Equity, Debt or Hybrid Funds. Your type of mutual fund schemes will vary depending on their performance. Some examples of risk are:
Sudden surge in Covid-19 cases in India could impact the future of equity Markets.
Equity has risks involving volatility of the markets, quality of stocks invested, etc.
Debt and hybrid funds also have other risks such as a) portfolio risk, b) change in Government policies affect portfolio component and quality of papers or c) rating agencies downgrading various money market papers.
Investment Strategy- Ensure that the investment strategy followed by a mutual fund company aligns with your goals and if it is conflicting, you should evaluate the reasons for it. It is suggested to go for a long-term approach instead of chasing returns that carry high risk.
Expense ratio – The expense ratio is the commission or the fee charged from the investors to manage their investments. As an investor, you must target mutual fund schemes that have a low expense ratio.
Exit Load – Exit load refers to the fee charged by mutual fund companies from investors while exiting from a particular mutual fund scheme.
Fund Manager and Fund House – Check for the credibility of the fund house. Past performance may not sustain in the future is a reality. Do not blindly follow star performance. They could be futile in the future.

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