TomorrowMakers ™

Financial Planning

Equity Linked Savings Schemes: High returns + tax savings (Part I)

12 January 2016
As the time to file tax returns draws closer, it’s prudent to explore various ways one can save tax. One such avenue is ELSS or Equity Linked Savings Schemes.
 

In the midst of tax season, thousands of us get e-mails from our employers asking us to produce proofs qualifying investments made under Section 80C, so that we may avail tax deductions.

This sends most of us in a tizzy and we start investing in the first thing we can get our hands on. Please don’t do that.

There are far too many people who think this is a good idea, and end up losing money and precious time. Instead, let’s look at one of the smartest investment instruments available in the market in a two-part series: ELSS.

What is an ELSS?

An Equity Linked Savings Scheme (ELSS) is an open-ended Equity Mutual Fund that not only helps you save tax, but also gives you an opportunity to grow your money. It qualifies for tax exemptions under section 80C of the Indian Income Tax Act,1961.

Features of an ELSS

The following are some of the features of an ELSS:

  • ELSS is a type of diversified equity mutual fund that invests across sectors
  • ELSS is an open-ended mutual fund which means that it does not have restrictions on the amount of shares the fund will issue
  • There is a mandate to keep at least 65% of the total funds invested into equity at all times
  • ELSS qualifies as a permitted tax saving instrument under Section 80C of the Income Tax Act. You can claim a tax deduction on investment up to Rs. 1.50 lakhs in a financial year.
  • There is a lock in period of 3 years from the date of investment in the scheme. So if you’re investing through systematic investment plan (SIP) mode, every SIP will be subject to a separate 3-year lock-in.
  • Like most equity funds, ELSS funds have both growth and dividend options. With Growth schemes, you get a lump sum pay-out after the lock in period of 3 years. With Dividend schemes, you get a regular income during the lock in period, whenever dividend is declared. Both returns- capital appreciation and dividend- earned on an ELSS scheme are tax free
  • Since 2009, entry load is not applicable across mutual funds. These schemes are also not subject to an exit load.

Related: ULIPs vs Mutual Funds- Where to invest?

Is ELSS is a good investment choice?

When we speak of investment avenues under Section 80C, one generally comes across fixed income options like PPF, NSC, 5-year bank FD, etc. However, ELSS scores better in the following ways:

  • ELSS has the least lock in period as compared to other avenues. So, where PPF and bank FD comes with a fifteen and five-year lock-in, a lower three-year lock-in in case of ELSS is very comforting to investors as it provides greater liquidity
  • ELSS invests predominantly in equity. Equity as an asset class has rewarded investors the most and has also beaten inflation handsomely. If we see the 10 year returns from ELSS category, it stands at 12.69% which beats the 8-9% available under the fixed income options, by a considerable margin.
  • ELSS funds fall under the exempt-exempt-exempt (EEE) category. This means that tax deduction on ELSS is three pronged:
    • Investments in ELSS funds exempt from Tax Deduction under sec 80C
    • Capital gains generated by the fund are also exempt as investments are not withdrawn
    • Withdrawals are also exempt as there is no tax payable on capital earns generated from equity oriented mutual funds
  • With other open ended schemes, fund managers are sometimes weary of investing in funds even if they promise high returns because there is the risk that investors can withdraw anytime. Thus, the lock-in that comes with an ELSS is actually a blessing as it helps a fund manager to take high conviction bets knowing that the funds are for long term. This goes a long way towards helping earn better returns as compared to other open-ended schemes.

Related: Simply ways to diversify your financial portfolio

Having said that, since ELSS schemes have a substantial allocation towards equity, the returns from these schemes will carry short term fluctuations. Hence, you should keep in mind your risk profile & financial goals before taking an investment decision. Instead of planning to withdraw funds after 3-year lock-in is over, you must be willing to stay invested for a minimum time horizon of 7-10 years to get the highest returns possible. If you cannot do so or find that you need the money before that time, it is advisable to skip ELSS and consider other available fixed income options. If you’re not sure, you should consult a financial planner who can guide you properly.

Related: Investment options- thinking beyond the obvious

To know the best available ELSS schemes available and how to invest in them, stay tuned for Part 2 in this series. If you have any specific questions, feel free to leave them below.

 

 
 
 
 

"An investment in knowledge pays the best interest"

- Benjamin Franklin -

QUOTE OF THE DAY

POLL

 

MOST VIEWED CONTENT

5 situations where you should never use a credit card
Financial Planning

5 situations where you should never use a credit card

While credit cards come with a host of benefits, they must be used carefully, and never in these situations!

8 common money habits which are illegal
Financial Planning

8 common money habits which are illegal

When it comes to money and financial matters, it’s usually better not to take a shortcut.

Where do Indians spend money? [infographic]
Financial Planning

Where do Indians spend money? [infographic]

Are Indians still spending the same way they did 20 years ago? Read on to find out!

Buying gold? 5 things to check before you buy
Financial Planning

Buying gold? 5 things to check before you buy

Gold not only has ornamental value but is also an excellent investment option that can withstand just about any economic volatility. Here are 5 things you need to know before buying gold.

4 Situations Every Home Owner Fears
Financial Planning

4 Situations Every Home Owner Fears

Most common things people are afraid of when they own a house.

Financial planning for dummies: a 7 step guide
Financial Planning

Financial planning for dummies: a 7 step guide

Regardless of your age, gender, income or location- you need to financially plan for retirement. To take the complexity out of the process, we’re giving you a 7 step guide to a secure future.

boy

We would love to hear from you!

Question, comment or concern? Our contact form is the best way to get in touch. We will respond to you within 5 working days.

newsletterNEWSLETTER