This might be too basic a post for most subscribed readers of this site. But tax saving mutual funds are typically the first point of entry for most new mutual fund investors. So it made sense to have something on it. The whole post has been written in F.A.Qs, with clearly visible Qs. Feel free to jump skip all the questions you are certain you know.
We’re not going to explain what an equity mutual fund is. If you don’t fully understand how an equity mutual fund works, try the links at the end of the post.
What are tax saving mutual funds?
They’re a special kind of equity mutual funds.
- They have a 3-year lock-in.
- They help you save taxes. Your investment into it qualify for a deduction under Section 80C.
- They primarily invest in large-caps and blue chips.
- Since they’re intended to help you save money for our future, these mutual funds are also called Equity Linked Savings Schemes — ELSS for short.
Who should invest in tax saving mutual funds?
To invest in them and be carefree about the decision, you need to meet all this criteria.
You absolutely don’t need the money you’ve invested over the next 3 years
- In the first 3 years, you have no access to your money whatsoever. It’s a complete lock.
- If you’re investing monthly using an SIP, the units you received at the end of your SIP, will move out of lock-in 3 years later. FIFO. Get?
You don’t need most of that money over the next 7 years
- Equity investments( tax-saving, stocks, mutual funds or otherwise) aren’t like FDs. They aren’t supposed to go up day after day, year after year.
- Sure they generate better returns than other asset classes, but they take time.
- During this time, your investment may grow very little, shrink in value or grow a lot. There’s no way to predict a market recession, a correction or a crash.
- Even economists and financial pundits can’t — case in point, they predicted a recession each year for the last 10 years.
- So over these five to seven years, you should be comfortable with the idea that your money hasn’t grown, or that it’s even reduced in its value.
You understand equities reasonably well
- If not, there’s a likelihood you might be in for much disappointment.
Tax saving mutual funds : What happens after 3 Year lock-in?
- You’ll be able to sell the units which have finished 3 years anytime you please.
- There are no restrictions thereafter. It’ll then behave as any other non tax-saving mutual fund.
Tax saving mutual funds : Should you sell them after 3 Years?
The simple answer; No.
There is no reason to sell/liquidate a tax-saving mutual fund, just because it’s out of the 3 year lock-in period. The point being, that selling off or liquidating any of your investments should be based on your goals.
After the 3-year lock-in, nothing about the fund changes fundamentally. The fund manager still runs the fund the same way as he/she did earlier. So if the fund has continued to perform well, you can stay invested and let the money grow.
Equities work best when you stay invested for the long term. See the best and worst of what happened to 1 Lakh of investment in a equity mutual fund, when it was left untouched for 20 years here. This, despite the stock market witnessing several minor and at least one major crash.
So, unless you need the money to fund an immediate need, stay invested. Or, you could even choose to move only some of it into debt product, and let the rest grow.
Remember though, that debt mutual funds and debt products like FDs are a good way to protect your money, but not grow it. So you’ll need to strike a balance, depending on how much of it you can let grow, and how much you need to protect.
This answer applies to any equity mutual fund investments; not just to ELSS funds. Always invest/liquidate based on needs and goals. And if necessary, stagger your sales/shift across asset classes.
[That last sentence might be a little hard to comprehend for beginners. If you did find that tricky, I urge you to read up more. This is stuff which will help through your entire lifetime.]
Book’s page numbers for reference
- To understand more about mutual funds in general, try pages 80-98
- To read more about tax-saving mutual funds, try pages 86 and 91.
- Understand large caps and Bluechips pages 29 through 62.
- To understand deductions and exemptions, try pages 186-200