With less than a month left in this fiscal year, perhaps this is the right time for investors to analyze various tax-saving investment options that can reduce their income tax liability and also help them generate decent returns. There are various tax-saving options available and the most popular among these are Public Provident Fund (PPF), Employees Provident Fund (EPF), bank fixed deposits, Unit Linked Insurance Plans (ULIPs), National Savings Certificate (NSC), Sukanya Samriddhi Account (SSA). Amongst all these, Equity Linked Savings Scheme (ELSS) has gained popularity over the years owing to a range of benefits that it offers over other alternatives.
Equity Linked Savings Schemes (ELSS) are simple diversified equity mutual fund schemes with additional benefits that offer a tax incentive for the investor and come with a lock-in period of three years. ELSS investment provides tax benefits under Section 80C of the Income Tax Act up to Rs 1.5 lakh of investment in a financial year. Investors are free to invest more than this designated amount, but the excess amount over Rs 1.5 lakh will not qualify to avail the tax benefits under Section 80C.
With the introduction of Long Term Capital Gains (LTCG) tax on equity returns in the last year’s budget, returns generated from ELSS schemes attract LTCG at 10% above a gain of Rs 1 lakh in a financial year. In addition to the tax on the profits, dividends received from equity schemes, which were tax free in the hands of investors till financial year 2018, now attract a dividend distribution tax of 11.64 %. In spite of the new tax implications on the returns, equity-oriented ELSS continues to be the preferred option for tax saving for investors under Section 80C. The following table provides a quick glimpse at how ELSS compares with the other commonly used tax-saving investments:
Following are some of the reasons that we believe make ELSS a better tax-saving investment option:
Shortest lock-in period
ELSS when compared to other tax-saving investment options has the shortest lock-in period. Instruments like PPF and NSC have long lock-in periods of 15 years and 5 years, respectively. This means unlike a Public Provident Fund (with 15 years’ lock-in period), National Savings Certificate and Employee s Provident Fund, all of which require a minimum of 5 years lock-in period, ELSS is a better bet with just 3 years of commitment. This makes money invested in ELSS funds much more accessible than other instruments. Even though it has the shortest lock-in period, it is always advisable to stick around for longer duration to realize the full potential of equity investments.
Provides a professional platform for exposure to equities
Investors with higher risk appetite who want to take risk actively in their portfolios usually look for equity investments and ELSS funds can add immense value to their investment portfolios. Although NPS and ULIPs also invest in equities, but these instruments provide a restricted exposure to equities, whereas ELSS remains an effective product which can gives exposure of around 80-100% into equities. Thus, in addition to the inherent tax advantage, one can accumulate wealth towards achievement of long-term financial goals.
Higher Returns on Investment (ROI)
To generate wealth in the long term the investment should generate an inflation-beating return over the period of investment. Fixed-interest generating securities like NSC and PPF yield returns in the range of 7 to 8% and Sukanya Samriddhi Yojana delivers a slightly higher interest, but the after tax returns on these instruments do not provide a very big cushion over inflation. Investments in the ELLS over a long term have provided returns in the range of 12 per cent and, therefore, ELSS returns stand out in comparison to the returns of its peers.
The lock-in period enforces financial discipline
To generate wealth from equities, it is time that matters more than timing. Normally, holding onto good stocks and good mutual funds for longer periods increases the probability of generating higher returns. Since ELSS has a compulsory lock-in period of three years, the investor is required to hold it for three years by default and as a consequence the possibility of booking profits or losses too soon is eliminated. Also, in ELSS funds, one may invest regularly by using a Systematic Investment Plan (SIP). The most important benefit of SIP lies in financial discipline which it inculcates in the investor. When one invests small amounts regularly on a monthly basis, it lowers the liquidity pressure, which he/she might face at the end of the financial year, and also it helps the investors in navigating market volatility through rupee cost averaging.
Unlike other market linked investment options such as ULIP that do not provides investors the flexibility to shift their investments to other AMC s due to longer lock-in period, ELSS offers more flexibility in that regards. If one is unhappy with a particular ELSS fund, he/she is free to move their investments to some other ELSS scheme after three years. If the ELSS investment is done through the SIP route, one can discontinue a particular SIP and start a new one.
The following table summarizes the average returns of all ELSS funds that are currently available in the marketplace. As it can be seen that as we move to longer time-frames, the ELSS returns are significantly higher with a five year average return in the range of 16 per cent. For investors, to maximize their return potential it is, therefore, advisable to invest in the ELSS funds with a long-term perspective. The Indian equity markets have witnessed a sharp correction in the midcap large cap space in 2018 and early 2019. As a result, good quality stocks in the space are trading at attractive valuations, and the chances of generating decent returns from ELSS funds focused on mid cap and large cap funds therefore are high at this point. It is, therefore, advisable for investors to get into ELSS funds focused on small caps and midcaps with a longer time horizon. Investments in these funds should preferably be done through the SIP route.
ELSS helps to build discipline given that you can t touch the fund for the lock-in period of three years, but the even better part about these funds is that they are a strong shield to weather the volatility that comes with investing in stock markets. The scheme not only benefits from the market highs, but also has provisions to lessen the impact of the lows. It is one of the best investment options that offer tax benefits with potentially higher returns and short lock-in periods. Also, one can continue to invest in this scheme even after the completion of the lock-in period of 3 years. The risk involved with ELSS is higher when compared to a Fixed Deposit or PPF, but the returns are potentially higher as well.
(By Rahul Agarwal, Director, Wealth Discovery/EZ Wealth)