Most of the tax saving instruments under Section 80C are savings
oriented instruments with returns after adjusting for inflation either
in the negative or slightly positive. The exceptions to this are the
ULIPs (Life and Pension Funds) and the ELSS Mutual Funds. The advantage
with ELSS compared to the ULIPs is the frequency (mostly a single
investment or a monthly investment for a year) and term for investment,
for getting good returns.
What is an ELSS?
An
ELSS (Equity Linked Savings Scheme) is a mutual fund that has to invest
a minimum of 80% in Equity Shares. The balance 20% can be in debt,
money market instruments, cash or even more equity. There is a 3 year
lock-in period for the ELSS mutual funds. Post the 36 months, the funds
remain invested and work like any other open-ended mutual fund.
Why an ELSS?
It
has been an established fact that in the long run equity gives a much
higher inflation adjusted returns when compared to any other investment
except for maybe real estate. The top 5 ELSS funds have given returns
from 22% to 26% compounded annually over the past 5 years. This is again
higher than the market (Nifty) returns over the past 5 years which is
at 19%.
ELSS is part of the Section 80C instruments which are
cumulatively eligible for a deduction from income up to Rs.1L. This
gives the tax payers benefits from 10% to 30% (excluding the educational
cess) based on their current tax slab.
The return (maturity and
the dividend [(if opted for]) from the ELSS is also tax free under the
present EEE (Exempt - Exempt - Exempt) regime.
The 3 year lock-in
period makes sure one stays invested. Otherwise in a normal mutual fund
one tends to withdraw in case of any monetary requirement.
The
lock-in period also helps the fund managers to plan their investments
better and also to hold on to valuable investments as they do not have
to worry about sudden redemption pressures.
The above logic is
proved in the higher returns achieved by the ELSS funds when compared to
the market returns. Wealth creation because of this is much better than
most of the other mutual funds. Only some sector based mutual funds
have given better returns than the ELSS fund in the past 5 years.
Options with the ELSS
Salaried
people with a tight budget can opt for a monthly investment (SIP using
ECS). The automatic investment from the bank through ECS makes it an
easy way to invest.
Those who want an income in between can opt for the dividend option. This is particularly suitable for senior citizens. Also, the ELSS gives a tax free return compared to a bank or company deposit, which is taxable.
Limitations with ELSS
The
investment in an ELSS cannot be switched or closed before the 3 years
are completed form the date of investment. During market downturns, this
becomes a limitation as one can only sit and watch the funds go down.
One has the option of averaging when the market goes down, but an
investment to save tax may not be required in the year in which the
market is going down.
The lock-in works negatively also for the
monthly investment because the lock-in is calculated from the date of
the investment and not from the date the scheme was started. This means
that the 12th month's investment can be withdrawn only on the 48th
month. This is a disadvantage compared to ULIPs, where the lock-in is
from the date of start of the scheme. But, still if seen charges part ELSS is better option, as charges have major direct impact on returns.
ELSS - a favoured option
Most
fund houses start an ELSS regular investment at Rs.500/- per month.
Single investments start generally at Rs.5000/-. This makes ELSS
accessible to all tax payers. With the compulsory lock-in giving better
returns than other investments, even the most risk averse can look at an
exposure to the ELSS fund for their tax benefits.
