1. How to invest in tax-saving mutual fund
ELSS (Equity Linked Savings Scheme) is the only kind of mutual funds that help you save taxes under the provisions of Section 80C of the Income Tax Act, 1961. There are two ways of investing in mutual funds. One is through Systematic Investment Plans (SIP) and the other by making a one-time lumpsum payment.
a. Lump sum investment:
It is a one-time investment you make, like say, Rs. 1,20,000. If you have a substantial disposable amount in hand and have a higher risk tolerance, then you may opt for making a lump sum investment.
Same Rs. 1,20,000 through SIP (Systematic Investment Plan) can be invested as Rs. 10,000 a month over twelve instalments. SIP is an ideal choice if you don’t have a lump sum to invest. As SIPs allow periodic investments, it has gained popularity of late.
2. Benefits of SIP over lumpsum investments
a. No need to time and constantly watch the market
Investors, especially inexperienced ones, are often not sure as to when to enter the market. If you invest a significant amount then there is always a risk of losing out a substantial portion when the market crashes. You also stand to benefit significantly during a market high.
With a SIP, your money is spread over time, and only some part 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
As investing through SIPs requires an investor to set aside a fixed sum periodically, you will inevitably become financially disciplined.
d. Ideal for budding investors
If you are someone who has just started in your professional career, then starting a SIP is the stepping stone to enter the world of investing. This way, you gain exposure to equities with a nominal amount. Later, you can venture into 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 than 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, it’s not advisable to make 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 will also allow for systematic investment.