Tax-planning in 3 easy steps

Having decided on the allocation to be made to equities (within the tax-saving sphere), the next step is to select a tax-saving fund. Broadly speaking, a tax-saving fund isn't very different from a conventional equity fund. Hence the parameters relevant while selecting an equity fund are applicable to a tax-saving fund as well. The 3-Yr lock-in is a differentiating factor that needs to be taken into account. Following is a 5-step strategy for investing in a tax-saving fund:

1. Scrutinise the fund house first
At Personalfn, we maintain that a fund house should make the grade before any of its funds can be considered for investment purpose. Hence, before selecting a tax-saving fund, ensure that its fund house passes muster. The fund house must be strong on investment processes; in other words, star fund managers shouldn't hold sway over the decision-making process. While a star fund manager can help the fund's cause only so long as he is associated with the fund house, a process-driven investment approach has longevity.

2. Avoid funds with a restrictive investment mandate
Investors should steer clear of tax-saving funds that have a restrictive investment mandate. For instance, some tax-saving funds are known to be positioned as mid and small cap offerings. Investors in such a fund could find themselves in an unenviable situation, if the mid/small cap segment hits a rough patch and large cap stocks emerge as the season's flavour. The situation is accentuated on account of the 3-Yr lock-in. While in a conventional equity fund, the investor has the opportunity to liquidate his investments, the 3-Yr lock-in, prevents him from doing so in a tax-saving fund.

Compare performances of leading tax-saving funds

3. Seek diversification
A common feature in several fund houses is that the tax-saving fund mirrors the fund house's flagship equity fund. Therefore, it is not uncommon to see the tax-saving fund have a portfolio and an investment style similar to that of the flagship equity fund. For the sake of diversification, investors should avoid being invested in two funds offering the same investment proposition. The financial planner has an important role to play in evaluating the portfolios and investment styles of various funds and helping investors avoid duplication in their portfolios.

4. Evaluate the fund on the returns front
Investors must evaluate the tax-saving fund's performance on the returns front over longer time frames i.e. at least 3 years. This is pertinent, given that the same is the minimum investment time frame for a tax-saving fund. Also, the fund's performance vis-�-vis its benchmark index and peers should be evaluated. Finally, investors should study how the fund fared during downturns in equity markets. While it is not uncommon to find even mediocre funds deliver a sterling performance in rising markets, it is in a downturn (read bear phase) that funds are truly tested.

How CAGR can be misleading

5. Evaluate the fund on other parameters
There is a lot more to a mutual fund than just returns. Its performance on risk parameters like volatility control and risk-adjusted return must be studied. Also the fund should have a track record of adhering to its stated investment mandate at all times. Only when the fund makes the grade on all these parameters and does so consistently, should it be considered for investment purpose.

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