If you are wondering what is the best way to save tax, mutual funds are the way to go, according to an analysis by Crisil Research, part of the CRISIL rating agency.
According a study of the tax saving mutual funds, called ‘equity linked savings scheme’ or ELSS in India, showed that they offered more than double the returns of debt-based instruments such as savings certificates.
“Our analysis shows that ELSS gave 26% and 22% annualized returns over three and 10 years respectively vis-à-vis 8-9% offered by traditional tax saving investment products such as Public Provident Fund (PPF) and National Savings Certificate,” Crisil Research said (see chart.)
The reason is not difficult to see.
The stock market goes up when there is too much money in the system. In other words, in times of inflation, performance of stocks is multiplied many times as excess money drives stock prices up. On the other hand, in times of economic uncertainty or downturn, stocks perform poorly, affecting the performance of mutual funds as well.
However, India has been facing relentlessly high inflation and a benign economic environment for the last decade, resulting in a stock market that has given handsome returns to investors.
So, Crisil said, if you are worried about inflation eating into your investments, mutual funds are the way to go.
“With average inflation around 7% over the past three years, top CRISIL-ranked ELSS gave an inflation adjusted return of 14%, which is significantly higher than returns offered by other tax saving products,” pointed out Mukesh Agarwal, Senior Director – CRISIL Research.
The minimum three-year lock-in period for ELSS provides the fund manager with a longer investment horizon and leads to a lower portfolio churn, the agency pointed out.
“.. investors who are willing to take some amount of market risk could look at ELSS to generate superior long-term returns,” the agency added.
There are about 48 ELSS schemes in India, not all of which have given great returns.
“The investment horizon should be more than five years for higher inflation-adjusted returns. Further, investors must choose funds that have performed well both in good and bad times,” pointed out Jiju Vidyadharan, Head of Funds and Fixed Income Research at CRISIL Research.
However, a word of warning: while banks and saving certificates will always give you a moderate amount of return, mutual funds may give you nothing, or even cause losses, if the general economic climate is affected and the stock market goes down continuously.