But it would not be right to compare the returns on a tax-saving fund with that of the PPF or the NSC. These small savings schemes offer a fixed return every year irrespective of market conditions; there is also complete protection of capital.

In a tax-saving fund, the value of your investment will move in line with the gyrations in the stock market. You also risk erosion in capital, should the market enter a moribund phase. Equity funds have managed exceptionally high returns over the past couple of years, as stock prices recovered from a depressed phase.

But if you enter equity funds at the present levels, the returns are likely to be more modest.

If you invest in a tax-saving fund now, you should not expect a secular rise in the value of your investment.

Instead, be prepared for temporary blips in value and for periods of low or negligible returns. If you hold on for a 3-5 year period, you can expect annual returns of 10-12 per cent.

Can I sweep the entire Rs.1 lakh that I have set apart for tax-saving investments into tax-saving funds?

One is to follow a thumb rule that uses your age group to gauge your risk preferences. If you are in your 20s or 30s, you can probably allocate 30-35 per cent of your savings to equity funds.

If you are in your 40s, you may need to reduce this exposure to 20-25 per cent. Your allocation needs to be toned down even further if you are in your 50s or 60s. Alternatively, you can tailor your asset allocation on the basis of your liquidity needs over the next few years. Avoid investing any cash that you may require within the next 3-4 years in tax-saving funds, as short-term fluctuation in the equity market may force you to exit at a loss if you are forced to redeem.

Timing can make a big difference to the returns from an equity fund. How do I reduce the risk associated with timing?

You can start an SIP for as little as Rs 500 a month with most tax-saving funds. By allowing you to dribble small sums into the equity market over an extended period, SIP investing allows you to reduce the risks associated with poor timing of your initial investment.

Remember, when you start a SIP with a tax-saving fund, each instalment that you invest will be locked in for three years from the date of investment.

For instance, if you start an SIP of Rs 1000 a month in January and continue to invest over the next two years until 2007, you will be able to withdraw your final instalment only by January 2010.

How do I choose a good fund? Do I go for the ones with the highest return?

While evaluating returns, remember that tax-saving funds differ widely in their stock choices and risk profile that can make a difference to the return. Most tax saving funds today invest in a mix of large and mid-cap stocks. Funds that invest predominantly in stocks of large-cap or blue chip companies are likely to earn moderate returns with a lower level of volatility.

Funds that invest a larger proportion in stocks of smaller/low-profile companies may deliver higher returns; they would carry a higher degree of risk.

Investors can hold a mix of funds with a focus on large-cap and mid-cap stocks. Franklin India Taxshield and Birla Equity Plan are tax-saving funds with a good record that have a sizeable allocation to large cap stocks. HDFC Tax Saver, HDFC Long Term Advantage and PruICICI Tax Plan appear to be good choices for funds with a mid-cap focus.

Can I consider investing in a tax-saving fund even if I don't want to avail of the tax breaks?

Due to their three-year lock-in period, tax-saving funds also attract the more stable kind of investors.

But do note that any investment in a tax-saving fund will carry a three-year lock in period. This lock-in period will apply even if you do not plan to avail of the tax break.

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