How to choose mutual funds to save tax?
Mutual fund as an asset class is gaining a lot of traction lately in India, and investors are investing heavily in different schemes of mutual funds to save income tax. There’s a famous saying in the world of finance, “You cannot avoid two things in life: death and taxes.” Indeed, we cannot avoid taxes, but we can plan to reduce them at least.
Mutual funds are an indirect way to invest in financial securities such as stock, bonds, etc. Here, the fund pools money from several investors, and then the fund manager invests that money in different securities depending on the objective of the fund. The fund manager is responsible for generating returns for you. You do not have to research stocks or other investments since the fund manager will do it for you.
There are myriad mutual fund schemes in India, from diverse categories like large-cap, mid-cap and small-cap, or multi-cap funds, to Equity Linked Savings Scheme (ELSS) and dividend-oriented funds, to name just a few. ELSS funds are income tax saver mutual funds. Such funds allow for deductions under section 80C of the Income Tax Act, 1961.
It’s prudent to consider such mutual funds that offer tax benefits. However, when selecting the best mutual funds under 80C, you should also look at a few other things to make a decision that is well-aligned with your financial goals. So, how to choose a mutual fund that’s best suited for you and helps save tax?
Here are some helpful parameters to compare mutual funds:
We tend to check the fund’s returns and compare them, but one parameter we miss here is ‘risk’. Sharpe ratio determines whether the returns generated by mutual funds to save tax align with the volatility (risk) associated with it. If you want risk-adjusted returns, then check this ratio of funds for comparative analysis.
This is one of the most important ratios in income tax saver mutual funds, as it measures a fund’s performance with respect to a benchmark. This ratio compares the fund’s performance to the returns generated by the benchmark index. A positive value means the fund outperformed the benchmark and vice-versa.
Beta, like alpha, is an essential risk ratio that helps in selecting the right mutual fund for your investment portfolio. It compares the mutual fund portfolio’s price fluctuations with that of the overall market. A beta of one means that the price fluctuations of the portfolio are in line with that of the market, while a beta of more than one means that the portfolio’s price is more volatile than the market. Similarly, a beta of less than one indicates that the portfolio’s price fluctuations are less volatile than that of the market.
This is yet another key statistical metric that defines the percentage of a fund’s portfolio to the fluctuation in the benchmark index. A higher value of this metric means that the mutual funds to save income tax align with the index’s performance. An ideal R-squared value is less than 80, and it should not exceed 90.
This is all we had for you in this edition of how to choose a mutual fund to save tax. We hope you now have a fundamental understanding of how to compare different mutual funds to save tax while also meeting other financial goals. Happy investing!