Though at present inflation is low, each of us would like to save as much on taxes and invest that amount towards our future financial security. Even incrementally larger sums of money, invested over several years can lead to huge differences in wealth creation. To make optimum tax saving and get the best returns, however, one needs to plan carefully.
Mutual funds which qualify to provide tax exemption under Section 80C of the IT Act can be an ideal investment for you. Under this provision individual tax payers can save upto Rs. 30,000 by investing Rs 1.5 lakh. The best tax saving mutual funds are mostly Equity Linked Savings Schemes or ELSS. The amount invested shall be deducted from your taxable income at the time of calculating tax liability.
ELSS works by investing most of the funds collected in equity related products and equity. They are mostly available with three years of lock in period and are suited for investors who have high risk profiles. ELSS schemes are usually open ended and investors can enter the fund at anytime. However, choosing the best tax saving mutual funds is difficult for retail investors.
Here are a few pointers that you can make use of for deciding the funds to opt for.
1. Returns- You should check the returns of different funds over 3 and 5 year periods. Many funds often outperform markets by sheer luck and good sense one or two years at best. It however, takes real talent to best the markets consistently for longer periods. Therefore, it would be wise to check the three and five year returns of funds.
2. Risk adjusted return parameter- You can look up listings which have the returns of funds adjusted against risks taken by fund managers. Risk adjusted returns signify the excess return that fund managers generate by taking a single risk unit. Based on the criteria, the risk adjusted return parameter judges whether the fund manager’s risk was worth it.
3. Risk Parameters- For any kind of investment, risk is the most important selection criterion. Only with higher risk is it possible to earn higher returns. Fund managers may have outperformed markets by simply selecting high beta stocks in the portfolio. High beta stocks are those which have high price volatility compared to the overall index or market volatility. For filtering out high return funds that have low risk, you can compare funds on measures like variance and standard deviation of returns along with the beta of a portfolio. These calculations can be gotten easily hence you comparisons would be easier.
The best tax saving mutual funds are available in two schemes- dividend and growth.