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This article tells you how to save taxes along with equity investments, using Equity Linked Savings Scheme (ELSS) MF.
Should you invest to save tax or for good returns?
We know that equity investments give the best returns in the long term. We also know that for most of us, investing in stocks through a mutual fund (MF) is better than investing directly in shares.
(Please read “Direct investment in Stocks versus Mutual Funds (MFs)?” for a detailed analysis)
But we usually have a limited amount to invest, and we always face this dilemma – should we invest in stocks to maximize our long term returns, or should we invest in tax saving, low-return investments to reduce our tax burden?
This is a difficult decision, and many times, the tax saving investments win. We end up investing in instruments that give only 7-8% returns, and sacrifice superior returns given by stocks.
But what if we can combine the best of both worlds? Is it possible to invest in equities, and still save tax?
Fortunately, YES. It can be done using Equity Linked Savings Scheme (ELSS).
Benefits and Features of Equity Linked Savings Scheme (ELSS)
All investments in Equity Linked Savings Scheme (ELSS) are eligible for benefit under Section 80C of the Income Tax Act (IT Act). Of course, this is subject to a ceiling of Rs. 1 Lakh per year, like other tax saving avenues.
ELSS is a special category of mutual funds that invest predominantly in stocks. They are very comparable to diversified equity funds. The only difference between regular diversified equity funds and ELSS mutual funds (MF) is that there is a lock-in period of 3 years. It means that once you invest in ELSS MF, you can not withdraw your investment for a period of 3 years.
Is the lock-in period so bad?
It might seem odd to have a lock-in of 3 years for a mutual fund (MF), but compare it with other tax saving investment avenues – the lowest lock-in is 5 years for bank fixed deposit (FD), and it can go all the way up to 15 years for Public Provident Fund (PPF).
So, the lock-in for ELSS is the lowest among ALL tax saving investment avenues!
And this lock-in period helps. Usually, fund managers keep a portion of the mutual fund corpus, around 7-10%, as cash, so that they can meet all redemptions. This cash is invested in very short term investments, generating meager returns. This impacts the overall returns of the MF.
Since the fund manager of an ELSS knows that you would not withdraw your funds for 3 years, he can invest all your funds, and thus, no part of your investment would be sitting idle as cash. Thus, you get superior returns through ELSS.
Actual returns of ELSS schemes
Let’s look at the actual returns generated by diversified equity mutual funds (MF), and by Equity Linked Savings Scheme (ELSS) MFs:
| MF Type | 3 Years | 5 Years |
| Equity Diversified MF | 48.66% | 53.02% |
| ELSS MF | 47.56% | 52.17% |
In this table, the returns for ELSS are without considering the initial tax saving. Assuming you fall in the 30% tax bracket, the returns for you would be:
| MF Type | 3 Years | 5 Years |
| Equity Diversified MF | 48.66% | 53.02% |
| ELSS MF | 66.20% | 63.40% |
Now, how does it compare?? Far superior, right? So, go ahead and invest in Equity Linked Savings Scheme (ELSS) mutual fund (MF).
Because ELSS is not for someone else…
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Hi raagvamd.
I am very impressed by your site and the wealth of information available on it. I had a query regarding investing in ELSS through SIP.
Say, as part of SIP, I start investing Rs 5000 pm from Sep 2008 regularly every month for the next three years in an ELSS MF. Now, my question is, at the end of three years in Sep 2011 , will I able to cumulatively redeem all the units that I have invested in ELSS since last three years OR only the units that were bought from Rs 5000 invested in the month of Sep 2008.
I am asking this because logically only the units invested in Sep 08 have completed three years till Sep 11 and rest all are yet to do so.
Hope you got the question. Thanks in advance
Amrit
Hi Amrit,
Thanks a lot for the compliments. I really appreciate it.
Well, most income tax rules are quite logical (most – not all!!)
So, your conclusion is totally correct – Each investment in a Systematic Investment Plan (SIP) of ELSS is treated as a separate investment in ELSS, and therefore, each has its own lock-in period of 3 years.
Coming to your example: The units bought in Sep-08 can be sold / redeemed in Sep-11, the units bought in Oct-08 can be sold / redeemed in Oct-11, and so on.
Hi Raag,
Another question for you on ELSS:
I had invested in ELSS in Jan-07 through ICICI demat account. I have all mutual funds units in demat form.
I want to close my demat account. I assume I can’t sell my mutual funds units as these are still in lock-in period of 3 years but at the same time I want to close my demat account. Is there any way this can be done?
I guess I will have to materialise MF units?
Can I transfer these units from ICICI demat to HDFC demat account?
Thanks,
Amar
Hi Amar,
You are right – you would need to keep the units for 3 years.
You have both the options open – you can either rematerialize the MF units, or transfer them to another demat account.
Hi Raag
First of all many compliments on maintaining such an informational site. This is my first visit to this site.
My question here is – whether long term investment switched from an ordinary equity fund to ELSS fund would be eligible for computing deductions under section 80C of that year (assume current year)? Or only ELSS fund bought from income generated in the current year will be eligible under section 80C.
My tax status is NRI, having income in India.
Regards
Anil Kumar
Hi Anil,
Thanks for the compliments. I am very glad that I am being able to help.
A switch from one scheme to another is equivalent to selling a scheme and reinvesting the amount in another.
Thus, if you switch into an ELSS scheme, such an investment would be treated as deductible under section 80C.
And you need not worry at all about the amount being the current years income – section 80C doesn’t require the amount invested to be from that year’s income.
Hi Jo,
As you can see, if we don’t take tax saving into the picture, both ELSS and EDMF are neck-to-neck. There isn’t much difference. So, you can see the long term performance of the schemes and choose the best among these.
Apart from these, you can consider Index funds. These have very low yearly expense ratios, therefore your returns can be higher.
But these funds are passive funds that mimic the returns of the Index (Nifty / Sensex / any other Index that is their benchmark), and I believe that in India, there is an opportunity to gain more through an actively managed fund.
So, it would be better to stick to ELSS / EDMF schemes.
raagvamd thanks for this site.
well my question is if tax saving is not a concern which one is better. ELSS for equity diversified mutual fund. i can see from your calculation that EDMF is better, but just thought of asking.
and is there anything even better than EDMF, when tax saving or insurance is not an objective.
Thanks,
Jo
Hi raagvamd,
I find your articles really informative and so i keep comin g back to enhance my knowledge.
I have two queries:
1) How the return (considering the initial tax saving), as mentioned by you above, for five years is less than that of three years and is it per annum return?
2) What about tax effects at the time of redemption of units i.e. on capital gains?
Thanks,
Jay
Hi Jay,
Thanks for the compliments – I am really glad that I am being of help.
1. The returns are annualized. Thats the reason the return for 5 years can be lower than the 3 year return – the equities boomed more during the last 3 years compared to the last 5 years as a whole.
2. Long term capital gain from equity MFs is tax-free. Thus, you would not have to pay any income tax on the gains from ELSS MFs.
For more about taxation of capital gains, please read “Long Term and Short Term Capital Gain – Income Tax Calculation“.
hi,
Is tax applicable when we redeem the ELSS units?
Hi Raagvam,
I am planning to invest in ELSS through SIP of Rs. 1000/- pm. Suppose i start with my first SIP in February – 2009. Then for tax deductions, will the amount invested in month of February and March will be included or for the complete year.
i.e only Rs 2000/- (Feb+march) will be considered for tax deductions or Rs 12000/- will be considered for tax deductions for the year 2008-2009?
Thanks in advance
Hi Deepak,
When shares or MFs are help for more than 1 year, any gain from the sale is considered Long Term Capital Gain (LTCG). And there is no tax on LTCG from the sale of shares or MFs.
(Please read “Long Term and Short Term Capital Gain – Income Tax Calculation” for more information on this).
Since ELSS units have a lock-in of 3 years, any gain from their sale would be LTCG, and therefore, there would be no tax on it.
Hi Rakesh,
For claiming income tax benefit for a particular year under section 80C, the investment needs to be made in that year itself.
Thus, you can claim 80C deduction for the year 2008-09 only for the amounts invested in 2008-09.
Since you would be investing only Rs. 2,000 in 2008-09, you would be able to claim only Rs. 2,000 for this year.
You would be able to claim the remaining Rs. 10,000 in the year 2009-10, as those investments would be made in that year.
How better is investing in ULIP compared to ELSS funds??
Hi Deepak,
Well, ULIP and ELSS are fundamentally different, so strictly speaking, a comparison would be improper.
But since both are used for making investments, and are available for saving income tax, let me compare them anyway!
ULIPs
ULIPs are insurance products – they offer you insurance, and along with it, they also invest your money.
You have some say in where your money is invested – you can choose a debt heavy fund, a balanced option, or a fund that invests heavily in equities.
But your choice is limited to the 4-5 funds available with your insurer. Also, ULIPs are usually long term products – 10 to 15 years.
ELSS
ELSS are tax saving mutual funds – they are pure investment products. (Although some schemes might provide some insurance as well).
The lock-in is 3 years, after which you can withdraw your money if you are not satisfied with the performance of your ELSS scheme.
Also, there are many ELSS schemes available in the market – so you have a lot of schemes to choose from.
Conclusion
Considering the variety available and flexibility to withdraw money, I believe ELSS are much better investment products.
If you want to get insurance too, ELSS + term insurance is a very good combination. Please read “Are ULIPs a costly form of term insurance plus MF investments” for more.
Hi Raagvam,
I am a retired person, but last year got an appoinment in an organisation planning to put up aluminium unit abroad. Hence I do not have any saving from income, have put in PPF upto its maximum limit.
The balance of Rs 30,000/- would like to invest in ELSS, but want to know that do I have put this amount every month for next three years, or next year I do not do put anything, and get this amount (+benefit) back after the lock in period of three years? another info does ELSS have nomination fascility ?
Eagerly waiting as the time left out just 45 days.
Regards,
A.H.M.Dhanani
Hello,
It looks like you are getting confused between ELSS and Syatematic Investment Plan (ELSS).
ELSS is a type of MF, whereare SIP is a method of investment in any MF. So, you can also invest in ELSS using SIP.
Let me clarify.
If you opt for SIP, you have to pay a fixed amount every month for a pre-selected period.
ELSS is like any other MF scheme, where you invest whenever you want to. If you opt for SIP in an ELSS MF scheme, you have to pay the fixed amount every month for a pre-selected period.
Now, to answer your query:
Investment in ELSS is not recurring (unless you opt for SIP, as discussed). So, you can invest the whole Rs. 30,000 now in one go. You would have a lock in for 3 years, and after 3 years, you would be able to sell the units of the ELSS MF scheme.
However, I always advise not to put all your money in stocks / mutual funds in one go. So, even for ELSS, it is better to stagger your investments.
We still have 45 days for making the investment – so, maybe you can invest Rs. 10,000 threetimes, with a gap of 15 days between the investments. That way, you would average out your cost of acquisition of the units.
Nomination: As I said earlier, ELSS schemes are just a variant of MFs. Thus, there is nomination facility available for them. Please talk about this with your agent / broker while investing in the ELSS.
Hi Akshay,
Thanks a lot for the kind words…
When you invest in an ELSS MF scheme, you are committing yourself to a lock-in of 3 years. Even in case of an emergency, you can not withdraw this amount.
Therefore, if you think you might need some amount in an emergency, you should not invest such amount in ELSS – ELSS is not liquid at all for the 3 years of lock-in.
When you invest in ELSS through an SIP, you are just investing a fixed amount in ELSS regularly – each investment is a separate investment, and the lock-in of 3 years is applicable to each investment separately.
Let’s say you start your SIP in Aug 08. Thus, amount invested in Aug 08 can be withdrawn only in Aug 11, and amount invested in Sep 08 can be withdrawn only in Sep 11.
Thinking logically – tell me why an amount invested in say Feb 2010 be allowed to be withdrawn in Aug 11, when the lock-in is for 3 years?
Note: In case you are looking for an investment where you invest a fixed sum regularly, and get back the entire amount at maturity, a recurring deposit is the right product.
Check out these articles:
- An introduction to Recurring Deposit
- An introduction to Post Office (PO) Recurring Deposit (RD) Account
- Post Office MIS and Recurring Deposit Combo: Safe investment, good returns
hi dear,
kudos to you for having such a website….well going through one of the questions regarding 3 yr lock in for ELSS, if cannot withdraw all the units, whats the use in case of an emergency…eg i started investing in SIP in Aug’08. so in aug’11.. i can withdraw only the investment that i did in august’08. what if i want to withdraw all the amount in August’11…..can you pls clarify..this cycle would go on and on forever untill i sotp the SIP…i am suddenly now confused….
Hi,
Thnks for your response.
I have completly agree to your response but it is always hard to find GOOD mutual fund
I have come to know about a jeevan saral ATM plan by LIC which is primia facie looking good than PPF. Should I go for this instead of PPF. Else please provide comparative view on Jeevan saral ATM plan and PPF( or other).
Thanks,
Rishi Gupta
Hi,
Thanks a lot for being a regular reader!
I believe the safest and simplest option for you to invest for your child would be PPF. It offers lots of benefits – tax savings at the time of investment, no tax on interest, and no tax at the time of withdrawal. (link to PPF article)
However, I can suggest a better strategy – equities are quite risk-free if investment is made for a long term. In fact, analysis of data from past many years also shoes that it is quite risk free. (link to articles) So, why not invest some amount in equity mutual funds to get better growth of investments?
Out of the Rs. 3,000 per month, you can invest Rs. 2,000 in PPF, and Rs. 1,000 in a SIP of a good equity diversified or an index based mutual fund. This is an option worth considering since your investment is going to be for a very long term.
Also, now that you have a new member in your family, its a good time to define some financial goals and start saving specifically towards them – instead of saving randomly. Please check out “(GBI)” for detailed, step-by-step instructions on this.
I always read your Article and responses which is very useful.
I have a query regarding childrens plan.
quickly I just go through about my Investment. ELSS SIP of 3000/-PM and some 50000/- ELSS over three yrs which done for 80c.
Apart from this, all my savings are invested( Long Term) in share market. I dont have any risk free investment till date.
Now I am blessed with a child and for her future I want to do some risk free investment. Initially I thought for PPF which gives me double the invested amount in 15yrs.
Recentally, I have heard some LIC scheme which triple the amount invested in 15yrs and another one is like PPF which double the invested money in 10 yrs.
I want to invest 3000 PM (annually 36000). Please advice me on this or give me some other option which you think good for me.
Hi Rishi,
I am sorry, but currently, I do not comment on individual plans, stocks or MFs. So, wouldn’t be able to help you there.
Also, if you are concerned about finding a “good” MF, you can invest in an index fund or index ETF. Just a thought…
Hi Bipinchandra,
I agree that saving 2.25% entry load would improve the returns on your investment.
MF houses do not charge an entry load when you buy directly from them (instead of going through agents or brokers). Please read “No entry load for Mutual Funds (MFs) – What does it mean for you” for more information on this.
Kindly let us know where to go for SIP investment without ENTRY LOAD deduction every month.
In such a bad market it is not wise to pay additional 2.25% entry load to enhance loss. It is learnt that GOI had already abolished the entry load.
kindly advise.
i Raag
First of all many compliments on providing such informational site.
I have a query regarding Redeeming my Fidelity ELSS fund .
What is the process of Redeeming it ?
Thanks & Regards
Sabah
Hi Sabah,
The process for redeeming an ELSS fund is the same as redeeming any other MF units – just that ELSS units can not be redeemed before the lock-in of 3 years expires.
I regularly read this forum by RSS feed. Please continue the good work.
I had invested in some ELSS funds one year back. I have not claimed this investment in 80C. Can i withdraw from ELSS, even though 3-year lock-in is not completed? In other words, is the 3-year lock-in applicable even if one has not claimed ELSS investments as part of 80C? Kindly respond.
Hi Sreenidhi,
Thanks a lot…
The 3-year lock-in is a feature of the ELSS funds, and not linked to the income tax savings. So, even if you haven’t claimed 80C exemption, you would not be able to withdraw the money before 3 years.
Hi Adarsh,
Thanks a lot – I am glad I am being of help… What you have suggested is a good strategy. However, I do not encourage blind investment – you should know what you want to achieve, and save towards that. I offer comprehensive, personalized financial planning service. If you avail of it, I can do proper financial planning for you. The financial plan would also have recommendations of the ELSS schemes you should invest in – I do not recommend specific schemes on the website. You can read more about the financial planning service at “My Financial Plan“.Dear Raag,
I am a new visitor of your site, and I find it very effective and useful for everyone who understand the value of investing.
My querry is regarding ELSSs available in the market.
I want to invest about Rs. 50,000 each year in three or four different ELSS schemes for tax saving and investment purpose as well. Is it a good stategy? Can you suggeest some good schemes in which i can put my money? Should I invest in different ELSS schemes every year or stick to same?
Thanks and Best Wishes
Adarsh Kumar Srivastava
Hi Raag
I am having ELSS around 1.5 Lakh in my name and since i can get benifix upto 1 lakh only so is it possible to show 50 K (50000) in the name of my Spouse (wife) as investment for tax benefit under 80c if yes what is the process.
Thanks a lot for all you comment as it is really helpful.
Thanks,
Pranav
Hi, I found your site interesting. Pease suggest the best ELSS fund to invest in. I have to invest 11,000/- this March 2010 for Sec 80C to save tax. Also suggest if open ended, or close ended one would be better
After lock-in period of 3 years, If I switch to same ELSS will that be treated as fresh investment. Please Help..
There are two different NAVs( just see the daily NAVs) for the same SBI TAX GAIN SCHEME, based on the dividend distribution option and the scheme is an ELSS which benefits under 80C Income TAx. How is this possible? Is the fund organizers taking investors for a ride?
Hi,
I have started investing in an ELSS fund from june’2010. It has 3 yrs lockin period. This fund is not at all perofming well. So I want to swith this ELSS Fund to Another ELSS Fund. is this posible?
Can you pls advice me on this??
Many thanks in advance for all your help!
Hi,
I am very new to investment world!!
I am planning to go for ELSS but have few queries in my mind.
Very basic one:HOW TO ASSESS VARIOUS ELSS Funds???
Kindly provide me the direction of analysing by answers/sources,etc.
THANKS A LOT…..:)