Effective Return On Tax Saving Mutual Fund Schemes Finance Essay - Free Essay Example

Savings are the tool used by a person or an organization that abstains from present consumption for a future use. Investment is an activity that engaged by people who have savings with the aim of achieving additional income or growth in values. It may be defined as a commitment of funds made in the expectation of some positive rate of return. Investors may have different aim for investing their money such as capital appreciation, regular return, safety, proud of holdings, additional return and tax benefits. They may expect to get back the money along with interest at a future date or the purpose may be the price appreciation on their investment or they may invest their money to get regular income from their investment, many investors consider other promised benefits like retirement benefit, accident coverage, etc., They seek the investment area where they can get maximum return and minimum risk. Some investors ready to face risk to have maximum returns. Safety of funds and regular payment in the mode of interest is expected by everyone. This can be possible only on bank deposit/ postal saving. Comparatively the returns of bank deposits are low than the investment in securities market. Among all other available investment, investor looks into the tax relief. They invest to have tax relaxation on their income for that they seeks better investment avenue which gives tax relief on their income. Even though they invested to have tax relief they expect return on the investment. Thus, this paper aims to compare the return on the investment in bank and tax saving mutual fund schemes with effective interest rate too. This study will helps to investors to evaluate their portfolio. Savings are the tool used by a person or an organization that abstains from present consumption for a future use. Investment is an activity that engaged by people who have savings with the aim of achieving additional income or growth in values. It may be defined as a commitment of funds made in the expectation of some positive rate of return.1 Investors may have different aim for investing their money such as capital appreciation, regular return, safety, proud of holdings, additional return and tax benefits. They may expect to get back the money along with interest at a future date or the purpose may be the price appreciation on their investment or they may invest their money to get regular income from their investment, many investors consider other promised benefits like retirement benefit, accident coverage, etc., They seek the investment area where they can get maximum return and minimum risk. Some investors ready to face risk to have maximum returns. Generally individual investor expects security on their investment. Safety of funds and regular payment in the mode of interest is expected by everyone. This can be possible only on bank deposit/ postal saving. Comparatively the returns of bank deposits are low than the investment in securities market. Among all other available investment, investor looks into the tax relief. They invest to have tax relaxation on their income for that they seeks better investment avenue which gives tax relief on their income. Even though they invested to have tax relief they expect return on the investment. Thus, this paper aims to compare the return on the investment in bank and tax saving mutual fund schemes with effective interest rate too. The dividend declared tax saving mutual fund schemes which are launched during the year 2000-05 have been selected for the purpose of study. This study will helps to investors to evaluate their portfolio. INVESTMENT PATTERN There are various investment plans available in the financial market to help investors to choose better suitable area to make their investment. Blue chip shares Growth share Income share Cyclical share Speculative share Equity Shares Financial Assets Treasury Bill Commercial purpose Certificate of Deposits Money Markets Investments Mutual fund Schemes 1. Equity shares 2. Debt Schemes 3. Balanced Schemes Real Estate 1. Agriculture Land 2. Semi Urban Land 3. Time share in a Holiday Resort Non Marketable Financial Assets 1. Bank Deposits 2. Post office Deposits 3. Co-Operative Deposits 4. Public Provident Fund Deposits Bonds 1. Government Securities 2. GOI Relief Bonds 3. Govt. Agency Securities 4. PSU Bonds 5. Debenture of Private Sector Companies 6. Preference schemes Endownment Assurance Policy Money Back Policy Whole Life Policy Premium Back Term Assurance Policy LIC Policies Financial Assets Gold Silver Precious Stones Art Objects Money Markets Investments Financial Derivatives Options Futures Figure 1 Various Investment Avenues[1] The objective of an investor comprised into three namely safety of investment, liquidity position and return on their invested money. The return on investment may further be classified into capital gain and the rate of return on investment as interest or dividend. Figure 1 shows all investment options presently available to the investors. Table 1 Summary Evaluation of Various Investment Avenues Investment options Return Risk liquidity Marketability Tax shelter Convenience Return yield Capital Appreciation Equity shares Low High High Fairly High Section 80C benefit High Non-Convertible Debentures High Negligible Low Average Nil High Equity Schemes Low High High High Section 80C benefit Very high Term Deposits Under Tax benefit scheme Moderate Nil Negligible High Section 80C benefit Very high Public Provident fund Nil High Nil Average Section 80C benefit Very high Life Insurance Policies Nil Moderate Nil Average Section 80C benefit Very high Residential House Moderate Moderate Negligible Low Section 80C High Fair Gold and Silver Nil Moderate Average Average Nil Average Every investor wants to get maximum economic advantage from their investment. Investment avenues are based upon the rate of return, risk and uncertainty, capital appreciation, marketability, tax advantage and convenience of investment. Table 1 gives clear picture which helps the investors to take their investment decisions on various financial market instruments. This paper seeks to have result for, Do the bank deposit returns and tax saving mutual fund schemes return vary? To find out the result for the above questions the returns of dividend declared tax saving mutual fund schemes launched during the year 2000 to 2005 have been selected and the study period was selected from 2006-07 to 2009-10 up to February 2010. TOOLS USED FOR ANALYSIS To examine the Performance of selected tax saving mutual fund schemes and bank return, various tools are being used. Rate of return, Standard deviation, Dividend yield ratio has been selected to examine the performance of selected tax saving mutual fund schemes and Future value, Effective interest rate is taken to analyze the bank returns. Net Asset Value (NAV) is a term used to describe the value of an entitys assets less the value of its liabilities. Higher the rate of return shows the better the performance of the fund. It can be computed as Ri = NAV i1 NAV i0 * 100% NAVi0 Where, i is the number of funds Ri is the rate of return of portfolio i NAV i1 is the net asset value of funds at current evaluation period NAVi0 is the net asset value of funds at previous evaluation period. Standard Deviation of fund measures the volatility level of return rates. The volatility level also describes the risk level. Usually, for higher rates of return the risk level will also become higher. Hence, the study includes standard deviation as the measure of risk level. It can be computed as ÃÆ' Ãƒâ€ Ã¢â‚¬â„¢i = ÃÆ'Ã… ½Ãƒâ€šÃ‚ £m j=1(Rij-R)2 m-1 ÃÆ' Ãƒâ€ Ã¢â‚¬â„¢i = standard deviation for portfolio i Rij = Rate of return for portfolio i on jth month R = Average return rates of m months. m = Time period Future value can also be used to calculate the future value of the deposits in a bank. Money has time value. The amount deposited in a bank will be increased with relation to the time. It can be calculated as Future Value = p(1 + k)n Where, k is the rate of interest n is the number of years p is the amount deposited Dividend yield is a financial ratio which shows how much a company pays out in dividends each year relative to its share price. Dividend is one form of return that the investor can get on their investment. In the absence of any capital gain, the dividend yield is the return on investment for a stock. It can be calculated as Dividend yield = Annual Dividends per share Price per share Effective interest rate is also called as effective annual interest rate. It is the annual interest rate that accounts for the effect of compounding. It can be calculated as Effective interest rate = (1+R/P) p-1 Where, R is the nominal rate P is the number of compounding periods. AN ANALYSIS OF TAX SAVING MUTUAL FUND SCHEMES Performance of the fund determines the interest of investors. Investors generally does not compare all the schemes and distribute their funds. But they want positive NPV on their investment. By comparing returns of various avenues the investor can know the better investment area. When a company trades their funds, the performance of the funds determines the capital appreciation of the funds. The fund appreciation increases the share trades and the investors actively involved in the purchase and selling of shares. The following tables Table 2a, Table 2b, Table 2c and Table 2d shows the NAV return of selected tax saving mutual fund schemes during the year 2006-07 to 2009-10 till February. Table 2a Net asset Value of Tax saving mutual Fund schemes    2006-07 ( 1 APR 2006 TO 31 MAR 2007) Company Name APR MAY JUN JUL AUG SEP OCT NOV DEC JAN FEB MAR DBS Chola Tax saver fund 5.05 -3.91 -17.16 2.53 9.06 6.84 5.35 6.34 1.15 2.94 -8.46 -9.86 HDFC long term advantage fund 4.75 -1.77 -16.32 1.74 6.12 7.09 4.36 3.95 0.84 56.84 -2.00 -18.35 Ing tax saving fund -16.86 -0.82 -23.98 -0.46 9.23 8.36 5.24 6.74 3.57 5.93 -1.50 -13.92 Kotak tax saver 9.01 -0.54 -23.14 -0.36 7.67 5.60 5.35 9.05 3.36 5.52 -4.72 -22.38 Principal personal tax saver 42.18 73.37 -22.89 -0.21 7.20 4.38 8.81 8.58 2.00 7.15 0.65 -8.74 Reliance tax saver fund 6.05 -1.32 -21.49 0.22 0.14 -7.35 -2.26 20.51 2.64 10.21 11.92 -15.49 Source : https://www.amfiindia.com/NavHistoryReport_Frm.aspx Table 2a Net asset Value of Tax saving mutual Fund schemes 2007-08 ( 1 APR 2007 TO 31 MAR 2008) Company Name APR MAY JUN JUL AUG SEP OCT NOV DEC JAN FEB MAR DBS Chola Tax saver fund 5.14 6.02 0.99 5.13 4.58 0.00 0.00 0.00 19.11 -5.96 -12.37 -10.69 HDFC long term advantage fund 2.15 6.62 4.23 4.87 -2.12 6.12 10.61 6.01 2.60 -3.74 -11.38 -18.98 Ing tax saving fund -17.94 6.97 3.51 4.53 -5.37 5.97 3.54 9.20 6.31 -4.30 -16.19 -11.87 Kotak tax saver 5.55 7.25 4.75 5.98 -4.18 5.48 9.02 6.84 10.44 -0.28 -27.95 -19.56 Principal personal tax saver 5.87 9.26 4.44 11.17 -1.49 8.08 5.91 3.57 9.12 -5.85 -11.53 -25.99 Reliance tax saver fund 2.52 5.23 2.19 7.83 -3.56 8.77 6.57 -1.21 8.57 -6.23 -12.26 -12.77 Source : https://www.amfiindia.com/NavHistoryReport_Frm.aspx Table 2a Net asset Value of Tax saving mutual Fund scheme s 2008-09 ( 1 APR 2008 TO 31 MAR 2009) Company Name APR MAY JUN JUL AUG SEP OCT NOV DEC JAN FEB MAR DBS Chola Tax saver fund 3.43 4.46 -10.23 -0.54 -5.61 -12.19 -22.52 -10.59 0.60 -1.05 -4.93 -2.42 HDFC long term advantage fund -2.59 0.48 -9.89 -6.68 8.82 -1.21 -20.34 -13.22 -0.78 -0.08 -3.43 -15.02 Ing tax saving fund 3.19 3.95 -9.90 -11.18 10.26 -6.93 -32.39 -11.71 -4.61 0.21 -3.75 -2.96 Kotak tax saver 0.09 4.61 -12.72 -10.64 7.30 -6.15 -25.03 -9.57 0.38 -1.64 -3.52 -3.31 Principal personal tax saver -29.55 3.33 -10.92 -9.33 8.14 -6.49 -28.00 -12.19 -2.79 -0.22 -2.85 -2.89 Reliance tax saver fund 1.07 3.28 -10.62 -8.11 6.62 -3.38 -17.19 -8.24 -1.05 1.34 -4.04 -2.41 Source : https://www.amfiindia.com/NavHistoryReport_Frm.aspx Table 2a Net asset Value of Tax saving mutual Fund schemes 2009-10 ( 1 APR 2009 TO 31 MAR 2010) Company Name APR MAY JUN JUL AUG SEP OCT NOV DEC JAN FEB DBS Chola Tax saver fund 24.76 22.78 15.88 -0.98 6.65 6.74 4.18 -0.38 4.00 2.49 -6.09 HDFC long term advantage fund 15.05 20.02 13.19 3.02 6.97 6.72 5.62 3.39 -36.70 2.59 -9.00 Ing tax saving fund 20.96 18.44 17.72 0.31 7.00 7.87 3.25 -0.09 5.26 3.73 -4.65 Kotak tax saver 16.18 18.95 16.34 -0.95 6.73 5.86 3.72 -1.13 3.98 2.18 -5.71 Principal personal tax saver -5.69 17.25 22.21 2.00 1.74 9.91 4.80 -0.11 1.01 1.68 -4.29 Reliance tax saver fund 17.18 16.26 15.27 0.40 5.72 -6.69 5.08 6.44 -1.44 4.64 -4.29Source : https://www.amfiindia.com/NavHistoryReport_Frm.aspx NAV return of selected tax saving mutual fund schemes moves in a similar direction during the study period from 2006-07 to 2009-10 up to February 2010. NAV return of all the schemes shows negative return in the month of June 2006, March 2007, and January 2008 to March 2008, June 2008 to November 2008, February 2009 and March 2009. No scheme falls in a pattern which helps to determine their return. During the year 2008-09 all the schemes produced maximum negative return. Whereas, during the year 2009-10, till October 2009 there were no negative return in all the schemes. It also has been noted that there was a fluctuation in all the month during the period of study. STANDARD DEVIATION Standard deviation has been used to measure the volatility selected tax saving mutual fund schemes. The volatility also denotes the risk level. Usually, there will be high risk for high returns. Hence, the standard deviation included to measure the risk level. The following table shows the risk level of selected funds. Table 3 Volatility of the Funds Company Name Standard Deviation DBS Chola Tax saver fund 2.444124 HDFC long term advantage fund 42.56922 ING tax saving fund 3.452677 Kotak tax saver 3.323016 Principal personal tax saver 100.9975 Reliance tax saver fund 2.398889 It can be noted from Table 3 that the fund volatility is very high principal personal tax saver and low in Reliance tax saver fund. From Table 4 it can be understood highest dividend given by principal personal tax saver and Reliance tax saver fund provides lowest dividend. Hence it can be stated that there is a relation between the risk and return. RETURNS IN THE FORM OF DIVIDEND Dividend is one form of return that the investors can get on their investment. Not all the company declared their dividends in all the years in a study period from 2006-07 to 2009-2010 up to February 2010. Table 4 shows the dividends declared by the various Asset Management Companies. Most of the companies declared their dividends in the year 2006-07. Table 4 Dividends Declaration S.No NAME OF THE COMPANY Rs. Per Unit 2006-07 2007-08 2008-09 DBS Chola Tax saver fund 1 HDFC long term advantage fund 6 6 3.5 ING tax saving fund 4 Kotak tax saver 3 3.5 Principal personal tax saver 82 Reliance tax saver fund 1 1 1.5 Source: www.moneycontrol.com, Date 26.03.2010 Principal Personal tax saver declared (maximum) Rs.82/unit dividend in the year 2007-08. DBS chola and Reliance tax saver fund declared (minimum) Rs.1/unit dividend in the year 2006-07. Table 5 shows the dividends returns of the selected tax saving mutual fund schemes. Table 5 Dividends Yield Returns Company Name Inception Year 2006-07 2007-08 2008-09 DBS Chola Tax saver fund 2005 0.08 HDFC long term advantage fund 2000 0.13 0.09 0.08 ING tax saving fund 2004 0.26 Kotak tax saver 2005 0.24 0.25 Principal personal tax saver 2002 1.16 Reliance tax saver fund 2005 0.08 0.08 It can be noted from Table 5, that highest return on dividend given by Principal personal tax saver in the year 2007-08. It also can be noted that principal personal tax saver not declared any dividend during the year 2006-07. HDFC declared Rs. 6/unit in the year 2006-07 and 2007-08. No company have declared the dividend in the year 2008-09 except HDFC long term advantage fund and Reliance Tax Saver fund. FUTURE VALUE Always money has time value. A rupee today is more valuable than a rupee a year. Money deposited today has future value after certain period. Hence future value of money calculated to know the value of investment. Table 6 shows the interest rate announced by RBI during the year 2006-07 to 2008-09. Table 6 Interest Rates Year 1 Years 1-3 Years Above 3 Years 2006-07 9% 9.75% 9.75% 2007-08 10.5% 11% 11% 2008-09 7% 8% 8.25% Source: RBI Annual reports It can be noted that the interest rate has been reduced to 7% in the year 2008-09. Table 7 Future Values of Deposits Year 1 Years 1-3 Years Above 3 Years 2006-07 1.09 1.32 1.59 2007-08 1.11 1.37 1.69 2008-09 1.07 1.26 1.49 Source: RBI Annual reports Table-7 shows the annually compounded interest returns. The rupee value of Rs 1000 in the year 2008-09 is increased to Rs. 1260 in the year 2012-13 at the rate of interest of 8%. EFFECTIVE RATE OF INTEREST Effective rate is the interest rate on financial product restated from the nominal interest rate as an interest rate with annual compound interest. Effective interest rate differs from calculating nominal rate. The nominal rate is calculated as multiply the number of periods with the interest. Table 8 Effective Interest Rate Year 1-3 Years 3-5 Years Above 5 Years 2006-07 9.0 10.1 10.1 2007-08 10.5 11.4 11.5 2008-09 7.0 8.2 8.5 Source: RBI annual reports Table-8 shows the effective interest rate. It can be revealed that the return is high for three years and above. The effective interest rate will be 10.1% where the nominal rate of interest is 9.75%. Table 9 Return on Investment in Bank Deposit (With Effective interest Rate Tool) Principal Interest Effective Interest Rate+ Principal 1000 10.1 Rs. 1303/- The Table-9 shows return on investment on Bank deposit. An investor deposited Rs.1000 with 8% interest the depositor gets Rs.1,303 with effective interest rate. Table 10 Return of Tax saving Mutual Fund Schemes Schemes 3 years dividend return alone NAV as on February 2010 No. Of Units on 2006 Unit value as on February 2010 Total Return (Dividend + Unit Value) DBS Chola Tax saver fund 80.23 13.163 80 1053 1133.3 HDFC long term advantage fund 356.25 34.453 23 792.42 1148.7 Ing tax saving fund 242.09 12.223 61 745.6 987.69 Kotak tax saver 484.06 9.657 74 714.62 1198.7 Principal personal tax saver 702.41 69.302 15 1039.5 1741.9 Reliance tax saver fund 256.83 13.701 73 1000.2 1257 The Table 10 shows the return of selected tax saving mutual fund schemes during the year 2006-07 to 2009-10 till February 2010. It can be noted from the table, the return of all the tax saving mutual fund schemes are lower than bank returns except Principal personal tax saver. All the tax saving mutual fund schemes NAV less than its purchase value on April 2006. If the investor made investment of Rs. 1000 on a bank, the investor may get Rs. 1,303 with interest and if they invested in tax saving mutual fund schemes they get less then Rs. 1,303. If they invested in DBS chola tax saver fund they may get only Rs. 1,133 and Rs. 987.69 if they invested in ING tax saver fund on February 2010. Security market is highly volatile, prediction on this market in not possible. It can be accepted through this study. There is no pattern on the NAV return. Many factors like global economy position, natural calamities, political change, etc., affects the return of security market Investment in Bank i s highly secured in all the period. CONCLUSION People invest money into known sources and they are not aware of pros and cons of the investment avenues in-depth and technically. They accept what the promoter / company or the agent says. By comparing the deposits/investments in bank and securities market, it can be noticed that the return from security market is high and it is volatile and there is no guarantee for the return. Those who wants high return, by taking high risk they can invest into securities market. Present scenario of the financial market is the securities market is in negative and there is no capital appreciation in the form of NAV returns. All sample schemes NAV goes into negative and only few company declared their lowest dividends. At present the bank return are high than the returns from securities market. Thus, generally people choose tax saving schemes to have minimum benefit from their investment. But there is no regulatory to provide guarantee on these schemes. It is necessary to create regulatory framewor k to safeguard the individual investors. The authority of mutual funds SEBI and AMFI involve into this area and may take necessary steps to protect the investors in the form of Regular return and Capital appreciation.