1. How to invest in tax-saving mutual fund
ELSS (Equity Linked Savings Scheme) is the only mutual fund that can help you save taxes (as per Section 80C). There are two ways to invest in a mutual fund. One is through Systematic Investment Plan (SIP) and the other by making a one-time annual lumpsum payment.
a. Lump sum investment:
It is a one-time investment you do for one year, like say, Rs. 12,000 annually. If you have a substantial disposable amount in hand and have a higher risk tolerance, then you may opt for a lump sum investment.
Same Rs. 12,000 through SIP (Systematic Investment Plan) will translate to investing Rs. 1,000 a month. SIP is an ideal choice if you cannot afford a lump sum investment. Some might also prefer it for its rupee-averaging benefit.
2. Benefits of SIP over lumpsum investments
a. No need to time and constantly watch the market
Investors, especially inexperienced ones, are often confused about the best time to enter the market. If you invest a significant amount, then there is always a risk of losing out a substantial portion of your investment in a market crash. You also stand to benefit significantly during a market high.
With a SIP, your money is spread over time, and only some parts of your entire investment will face the market volatility.
b. Rupee cost averaging
A SIP allows you to invest at different levels of the market cycle. When the market is low, the fund manager buys more units and can sell high when the market is at its peak. It will help to reduce the per-unit cost of purchasing the units. This phenomenon is known as rupee cost averaging.
c. Build the habit of investing
When you initiate a SIP, you invest a manageable but fixed sum in a tax-saving mutual fund scheme, instilling the saving habit in you.
d. Ideal for budding investors
If you are someone who has just started a career, then starting a SIP is one way to enter the world of investing. This way, you gain exposure to equities with a nominal amount. Later, you can venture to riskier but potent equity schemes if it suits your investment needs.
e. Better past performance
SIP investments have consistently earned higher long-term (5+ years) returns compared to lump sum investments.
3. SIP and lumpsum explained with an example
Suppose you have Rs. 10 lakh in your bank account that you wish to invest in ELSS. Unless you are market whiz who knows which scheme to select, we wouldn’t recommend a lumpsum investment.
There are two ways to invest this amount:
a. Start a monthly SIP of an amount that you are comfortable with. This could be Rs. 10,000, Rs. 20,000, or Rs. 50,000. Let the money stay in your bank account till all of it gets invested systematically in the chosen equity funds.
b. Invest the lump sum in a liquid fund. Then start a Systematic Transfer Plan (STP) from the debt fund to the ELSS. Your corpus will not only earn higher returns than a savings bank account but also allow for systematic investment.