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Patience Is The Key

I am 22 and I want to start investing with the future in mind. I want guidance on mutual fund investments as well as tax planning
- Anonymous

I am 22 years old and started earning this April. I earn around Rs 2 lakh per annum. I have already managed to save Rs 30,000. Now I want to invest in mutual funds as well as do some tax planning. I also want a life cover of Rs 5 lakh. Would appreciate some guidance.

It is commendable that you wish to begin investing at such a young age. In fact, this is the ideal age to make a start.
Get Started
Since financial responsibilities are minimum at your age, you should focus on wealth building. Being just 22, equity is an excellent vehicle for you. But the watchword here is patience. If you are willing to ride the ups and downs of the stock market without getting flustered, consider an equity fund.

The key is to invest regularly and stay in for the long haul. If you set aside just Rs 5,000 every month over the next 30 years at a rate of 11 per cent per annum, you will have Rs 1 crore by the time you are 52. That is the magic of getting time to work for you.

But you need to save every single month and learn the discipline of not being perturbed by market prices. The best way to do this is by starting with a Systematic Investment Plan (SIP) in a mutual fund where a fixed amount every month goes into a fund of your choice. (Refer to Buy Sell Hold to see benefits of SIP.)

A balanced fund would be the ideal way to kick start. These funds have considerable investments in debt and, hence, are less aggressive than pure equity oriented mutual funds. You can expect decent returns in the long run with no lock-in period whatsoever. Choose any top performing mutual fund like HDFC Prudence, DSPML Balanced or Tata Balanced. Once you are comfortable with the risks associated with mutual fund investing, you can venture into pure equity mutual funds.

Do You Need It?
Since insurance is not an investment, one has to evaluate the insurance needs on a case-to-case basis. If you don't have any dependents at this time, what are you buying insurance for? But if you are still keen on it, opt for a pure term policy. This is the most simple and purest form of life insurance. A term insurance cover of Rs 5 lakh for 25 years would cost you a meager Rs 1,200 per annum. Another plus point about term insurance; it is also the cheapest form of life insurance available.

The Inevitable
Think taxes. Think Section 80C.
This section of the Income Tax Act offers a deduction from taxable income. If you invest up to Rs 1 lakh in the relevant instruments specified under this section, you save tax up to that amount.

First you need to check if your employer offers a provident fund. If yes, a percentage of your basic salary will be deducted by your employer towards the Employee Provident Fund (EPF). Since you are considering a life insurance policy, the premium you pay is also eligible for deduction under Section 80C.

So total these two figures and see by how much you fall short of the Rs 1 lakh limit. If you still want to invest to save tax, then you can consider five-year bank fixed deposits, the National Savings Certificate (NSC) or the Public Provident Fund (PPF). All these are fixed return instruments with maturities of five, six and 15 years respectively. Tax saving bonds of different maturities are also brought out by financial institutions from time to time.

At your age, consider Equity Linked Savings Schemes (ELSS). These are diversified equity funds that offer a tax benefit under Section 80C. They have the lowest lock-in period (three years) and the capability to generate the highest return amongst other tax saving instruments. Also, you pay no tax on maturity unlike the other options. The PPF is an exception, but that could change in the future.

If you wish to select an ELSS, choose from Value Research's five- or four-star rated funds like SBI Magnum Tax Gain, HDFC Tax Saver, Sundaram Tax Saver or Franklin India Tax Shield.

Emergency Planning
Don't forget to create a contingency fund to meet immediate cash requirements in case of an emergency. For this, you can keep two to three months of your salary in a savings account, as it gives you accessibility 24x7. In fact, your savings of Rs 30,000 can be set aside and you can initiate SIPs with you regular salary from now on.
All the best!