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Equity Linked Savings Scheme (ELSS) is not for someone else

 

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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