IMPORTANCE OF FIRST MUTUAL FUND

The first fund you buy plays a major role in making or breaking your belief in stock investing. The experience earned in first investment generally becomes driving force for future investment decisions. I have come across so many people, who have invested in mutual funds seeing the great returns in last few years but find themselves in unchartered territory of negative returns and thinking to get out as soon as their investment turns green.

The above investing behavior is very common and often lacks proper financial education among common people. The prudent investing behavior is more essential than selection of best performing mutual fund.

It is therefore utmost important that investor to invest in right funds by right approach to fulfill their goals of high returns without losing their sleep.

There are two types of funds that are uniquely suitable as beginner funds. These are Tax Saving Funds and Balanced Funds.

Tax Saving Funds : Tax saving funds or Equity-Linked Savings Schemes (ELSS) are basically all-equity funds in which investments are eligible for tax exemption under Section 80C of the Income Tax Act. Under Section 80C, you can invest up to R1.5 lakh in a set of instruments, one of which is ELSS funds. Since they are equity funds, you should invest in them for the long term. In the case of ELSS funds, this long-term imperative is enforced under tax laws through a three-year lock-in. As a result, investors tend to have a good experience as they receive reasonable returns from these funds. Moreover, the tax-break acts as a natural boost to returns.

Balance Funds : Balanced funds, also called hybrid funds, combine equity and debt investments in a certain ratio. In order to maintain this ratio, the fund manager will typically disinvest from holdings that have gained more and invest in holdings that have gained less. This of course is asset rebalancing.

Effectively, gains that are made in equity are protected by debt. The great advantage of balanced funds is that they are inherently safer than pure equity funds. They gain well when the markets gain but when the markets fall, they fall less sharply, thus protecting gains that were made in better times.

To sum it up, your experience with your first fund will in many ways set the course for how you invest. Keep things simple by going for an equity mutual fund that will help you realize higher returns. To realize tax savings from your investment, opt for an ELSS fund. Finally, think long term.

ELSS SCORES OVER OTHER TAX-SAVING AVENUES

People often make sub-optimal decisions while choosing tax-saving investment options. This is mainly because lack of financial education, unclear financial goals and unawareness about right investment avenues.

Indian tax laws offer an exhaustive range of tax-saving instruments like the Public Provident Fund (PPF), tax-saving fixed deposits, National Savings Certificate (NSC), Equity-linked Saving Scheme (ELSS) and others. And yet, it is extremely common place for people to make sub-optimal decisions with their tax-saving investments. Why does this happen?

One of the biggest factors responsible for this is the widespread tendency to see tax-saving goals and investment goals differently. People are simply not thinking about tax-saving instruments the same way they think about other investments. That is to say, they do not priorities the returns on these investments in the same way.

Further, the typical investor makes this decision in late March when the dead line to invest is fast-approaching, or under pressure from a salesperson drives home to sell insurance products. The pressure may intensify if the salesperson is a relative or a friend. And the outcome is that a less-than-ideal decision is made. On realizing it later, they comfort themselves saying at least we got tax benefits.

This approach proves expensive in the long run. Confusion over what to look for in a tax-saving instrument prevents clear-headed thinking about what exactly one is getting out of an investment and whether the quantum of disadvantages are actually worth the quantum of tax benefits obtained.

Investors should work on eliminating the two sources of poor decision-making: time constraints and not thinking through these investments. Eliminating time pressure is simple. Just plan these investments as early in the financial year as possible. Then once you start investing, keep at it through the year till you reach your limit.

As far as the second problem is concerned, for most people, the investment that makes the most sense is an ELSS. Salary-earners generally have some of the permitted amount going into fixed income through PF deductions. To balance that, equity is advisable. ELSS is unique in being the only viable tax-saving investment within the Rs 1.5 lakh limit that brings the benefits of equity returns. Sure, there are two other options that give equity-linked returns - Unit-linked Insurance Plans (ULIPs) and the National Pension System (NPS). However, ULIPs have a longer lock-in period of 5 years, coupled with high costs and poor transparency. The NPS is a retirement solution rather than a savings one. It has only partial exposure to equity and a very long lock-in period that effectively extends till retirement age. There is no way a three year lock-in product like the ELSS can be compared to the NPS.

For many beginner investors, ELSS funds make an excellent gateway product, where they get their first taste of equity investing and of mutual funds. They end up investing in these funds because the tax-saving attracts them and it has the shortest lock-in, and this experience encourages them to invest in equity mutual funds over and above their tax-saving needs. Once you get used to long-term equity returns, you look to try other types of equity investments as well.

Equity investments carry higher risk over the short-term. However, for investment periods of five years or more, the risk is considerably lower. When you take inflation into account, bank FDs and similar deposits turn out to be sub-optimal because of inflation. Like all equity investments, the best way of investing in an ELSS is through monthly Systematic Investment Plans (SIPs) through the year. SIPs have two advantages here: first, they protect your investments in a market downturn, and second, you avoid making a hasty lump-sum investment in March. At the beginning of every financial year, estimate the amount you have left over from the Rs 1.5 lakh limit after statutory deductions; divide this by 12 and start an SIP.