How Opting For Tax Saving Funds At The Last Minute Can Spell Disaster   Dec 06, 2016


"I have to invest Rs 1 lakh in tax-saving mutual funds by March. Kindly suggest some good funds. Also, should I invest now or wait till March?" asks Puneet on an online forum.

When to invest is a question that confuses many savers. A tricky question indeed; even when it comes to tax-saving mutual funds also known as Equity Linked Saving Schemes (ELSSs).

However, after much dilly-dallying and procrastination, many end-up investing just before the deadline. The inflows in tax-saving schemes in the last quarter of the financial year is the testimony to last-minute rush to deploy hard earned money in ELSS. 

But does this habit bode well for you, the investor? Should you invest regularly, or wait till the end of the financial year?

You would have come across a postulatory reasoning: invest regularly, to benefit through rupee cost averaging. But in reality, does regular investing have an edge over investments made in the March quarter? Considering markets are extremely volatile, investing in the March quarter may have the same results as investing throughout the year.

In a unique research study, we work out the numbers to study whether ad hoc investments made at the end of the financial year work in your favour or not. We analysed this using the index values of the S&P BSE Sensex over a 26-year period from 1990 to 2016. As this will more or less reflect the performance of investments made in ELSS. We compared the average price of the index over 12 months to the last three months of a financial year, assuming the investment date as the fifth of every month.

Remember, the lower the average price (or cost) of your investments means you would have accumulated more units, resulting in higher portfolio value in future.

Our analysis found that investors would end up accumulating lower number of units nearly 70% of the time, if they invested only in the last three months of the financial year, as compared to investing the same amount over the entire year. Here, for the sake of simplicity, we will ignore the impact of the time value of money.

Over the past 26 years, in as many as 18 periods (or 69% of the time), the average price paid in the last three months was higher than the average price over the year. For investments in the March quarter that didn't work in your favour, you would have invested at a price that is comparatively 12% higher to the average price over the year. In as many as eight financial years, the excess price paid was 10%. On the flipside, there were only two occasions where the cost was 10% lower in the three-month period as compared to the average cost over the year.

In bull market periods, as seen between 2004 and 2008 and then again between 2013 and 2015, the cost of lumpsum investments at the end of the financial year would have been significantly higher. The only time a delayed investment would have worked best to your advantage was in FY2008-09, when the market had corrected by over 50% from the peak.

S&P BSE Sensex Regular Investment Ad Hoc Investment Higher Cost of Delayed Investment (in %)
Financial Year 12-month Average of S&P BSE Sensex Jan, Feb, Mar Average
1990-91 1,062 1,100 3.5%
1991-92 1,829 2,586 41.4%
1992-93 3,043 2,541 -16.5%
1993-94 2,813 3,724 32.4%
1994-95 4,011 3,665 -8.6%
1995-96 3,301 3,228 -2.2%
1996-97 3,440 3,520 2.3%
1997-98 3,833 3,604 -6.0%
1998-99 3,285 3,338 1.6%
1999-00 4,567 5,350 17.1%
2000-01 4,363 4,184 -4.1%
2001-02 3,333 3,443 3.3%
2002-03 3,220 3,280 1.9%
2003-04 4,463 5,880 31.8%
2004-05 5,802 6,642 14.5%
2005-06 8,178 9,985 22.1%
2006-07 12,355 13,597 10.1%
2007-08 16,647 18,631 11.9%
2008-09 12,557 9,188 -26.8%
2009-10 15,383 16,824 9.4%
2010-11 18,679 18,932 1.4%
2011-12 17,502 16,942 -3.2%
2012-13 18,172 19,529 7.5%
2013-14 19,957 20,796 4.2%
2014-15 26,484 28,714 8.4%
2015-16 26,463 24,948 -5.7%
Prices as on the 5th of every month. For non-trading days, the price of the previous trading day is considered.
(Source: RBI, PersonalFN Research)

Lack of proper tax planning may not only lead you to poor investment decisions, but can also lead you to invest in inefficient products. As in the case of ELSS, apart from investing regularly, you need to select the right scheme as well. Evaluate the performance track record (returns, risks, performance across market cycles), portfolio characteristics, costs, along with the investment processes and systems followed at the fund house. All this is time consuming, but needs to be done in order to avoid underperformers.
 

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Want to know the best tax saving funds for your investment portfolio? Click here

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Because of inadequate tax planning, you may also end up investing more than what qualifies for a tax rebate. This second query highlights the predicament of most individuals.

“My salary is around Rs 11 lakh per annum. I invest Rs 75,000 in LIC and Rs 1.5 lakh in SSY (Sukanya Samriddhi Yojana) on a yearlybasis. Still there is a tax deduction from my salary. Could you please guide me on whether I need to invest in any other policy to save tax,” reads a query posted by Mr Abraham.

Like him, several individuals are confused about income tax rules and the tax-saving options. They make ad-hoc investments to meet the deadline, so that their investment declarations are filed with their employer(s). They opt for life insurance policies—not as a risk cover, but only to save tax. This poor grasp of tax laws and lack of planning can lead to disastrous financial decisions.

As in the case of Mr Arbaham, his investments were much beyond the Section 80C limit of Rs 1.50 lakh, and this is excluding his contributions to the Employee Provident Fund (EPF) . Assuming his contribution to EPF is around Rs 50,000 per year, in all he is contributing as much as Rs 2.25 lakh to fixed income investments. This works out to almost 25% of his salary. Even if he saves 40% of his income, a bulk of his investments will be in low-income generating investment avenues.

By getting into the last minute rush, you may be unable to compliment tax planning with prudent investment planning. As result, you may end up owning investment products that aren’t suitable to your risk profile and may fall short of achieving long-term financial goals.

Taxation benefits should not drive your investment decisions. Rather, you should align your tax plan with your financial goals. You should also be mindful of the different avenues that qualify for tax deduction. You can include several expenses under Section 80C such as tuition fees, home loan principal repayment, insurance, and even your own EPF contribution. Apart from Section 80C , you can save tax vide other sections of the Income-tax Act, 1961.

For example, Section 80TTA provides a deduction of Rs 10,000 on interest income earned through your savings bank account. You can claim a deduction of up to Rs 5,000 on preventive health check-up under Section 80D. Apart from these, you can save tax through several other options. These are outlined in our latest tax-planning guide.

To conclude, here are a few pointers to help engage in prudent tax planning:



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