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An investor can save taxes with low risk while getting returns of equity funds. Here's how

Equity tax-saving funds are most sought after by investors who invest under Section 80C. These funds have managed to generate an astounding return of 41.30 per cent per annum in the last five years (as on June 2, 2008).

However, risk-averse investors tend to stay away from these funds because of the associated volatility and inherent market risks. Apart from the EPF and life insurance policies, these investors bank upon other low yielding instruments like PPF, NSCs or bank FDs for saving taxes. In the long run the tax-saving funds have outperformed all other instruments.

But have you heard of a strategy which would help you save taxes, protect your capital and also offer equity linked returns? We are suggesting you a six-year strategy that would help you do so. To illustrate this, let us assume that you have Rs 1 lakh to invest this year under Section 80C. We assume you are left with Rs 80,000 after your PPF/insurance investments. Now there are two ways to invest if you are risk averse. First can be to invest the entire amount in a secured investment like NSC, which offers you 8.16 per cent interest (per annum) for six years but the post tax return is only 6.02 per cent.

The second option is to follow this six year strategy (See Table). In this we divide the investment in NSCs and ELSS. The investment in NSCs is to be done in such a proportion, which makes the post tax return equal to the overall capital investment of Rs 80,000. The remaining can be routed to ELSS. Though the amount in ELSS is at risk, your capital is protected and you can expect superior returns with this equity exposure. This strategy would generate 11 per cent p.a. (post tax). However in both the cases, the tax on NSCs interest is not be paid in the sixth year. You should pay the tax each year after your NSC account is credited with interest. We have also assumed a conservative return on equity diversified funds (20%) and risk averse investors can adopt this strategy.

Though we have assumed this to be a six year plan, tax saving funds & NSCs both have a lock-in of only three years. So in case of an emergency you can always withdraw money after three years. But do note that the interest on NSCs would be reduced if you redeem them before maturity date.