Equity Linked Savings Schemes or ELSS schemes as it is popularly known are Tax Saver equity mutual Funds which invest in a diversified portfolio of stocks with the objective of generating capital appreciation for investors over a long investment horizon. Investors can get a tax deduction of up to Rs 150,000 from their taxable income if they invest in Equity Linked Savings Schemes (ELSS) under Section 80C of Income Tax Act 1961. Investors can save up to Rs 46,350 in taxes every year by investing in Equity Linked Savings Schemes (ELSS).
Equity Linked Savings Schemes have a lock-in period of 3 years; investors cannot redeem ELSS units before 3 years from the date of investment. Investors can invest in Equity Linked Savings Schemes in lump sum or through Systematic Investment Plans (SIP). By investing in Equity Linked Savings Schemes through Systematic Investment Plans, investors can not only meet their tax saving goals but can also take advantage of volatility in stock markets through rupee cost averaging. However, when investing in Equity Linked Savings Schemes through Systematic Investment Plans (SIPs), investors should note that each Systematic Investment Plans installment will be locked in for three years.
Wealth Creation Potential of ELSS
Section 80C investment schemes can either be risk-free or subject to market risks. Public Provident Fund, National Savings Certificates, Tax Saving Bank FD schemes, Tax Saving Post Office time deposit schemes etc. are examples of risk-free investments, while mutual fund ELSS and ULIPs (Unit Linked Insurance Plans) are subject to market risks.
If you do not want to take any risk, then Equity Linked Savings Schemes (tax saver mutual funds) or Unit Linked Insurance Plans (ULIPs) are not the right investment options for you. However, note that risk and return are directly correlated; you cannot get higher returns without taking risks. Even though Equity Linked Savings Schemes are subject to market risk, they are one of the best tax saving investment options for you, if you have long investment horizon.
Historical data shows that equity is the best performing asset class over a long investment period outperforming asset classes like gold and fixed income (debt). In the last 20 years from January 1997 to January 2017, the BSE Sensex has given 11.1% annualized returns, while gold has given 9.3% and fixed deposits have given 7.6% annualized returns respectively. Rs 1 lakh invested in the Sensex twenty years back would have grown to Rs 8.2 lakhs, while the same amount invested in gold and fixed deposit would have grown to Rs 5.9 lakhs and Rs 4.3 lakhs respectively.
The ELSS schemes have given superior return than the Public Provident Fund Scheme which is most popular with investors looking for fixed returns.
Let us assume you invested Rs 12,500 every month (annual Rs 150,000) in an Equity Linked Savings Scheme each year (at the beginning of the financial year) for saving taxes. Assuming an annualized return of investment of 15% you will accumulate a corpus of Rs 1.90 Crores over a 20 years period (ELSS category has actually given over 11% annualized returns in the last 10 years). If you combine the both – tax savings and wealth creation – the financial benefits of ELSS investments over a long investment period is huge.
Superior Liquidity of ELSS compared to other 80C tax saving options
Equity Linked Savings Schemes (tax saver mutual funds) offers higher liquidity compared to all Section 80C investment options. 80C investments like NSC, tax saving bank FDs, post office tax saving time deposits, Unit Linked Insurance Plans etc. have a lock in period of 5 years whereas Public Provident Funds (PPF) has a tenure of 15 years. Traditional life insurance policies also have long maturity period and if you surrender within the policy term period then you stand to lose a lot in surrender value. Equity Linked Savings Schemes (ELSS) investments have a lock-in period of only 3 years and thus makes it the most flexible Section 80C investment schemes from a liquidity perspective also.
Lock-in period of ELSS is beneficial to the long term investors
Over a long investment period, the 3-year lock in period in Equity Linked Savings Schemes is to the advantage of investors compared to open ended diversified equity funds.
Since the investor cannot redeem units of the scheme in the first three years, they are not affected by redemption pressures on account of short term volatility, which enables the fund manager to stick to his long term stock convictions. In the last 5 years, Equity Linked Savings Schemes (ELSS) on an average delivered 20% annualized returns outperforming the broader market. The top performing ELSS Funds have delivered between 22-25% compounded annual returns over the last 5 years.
This clearly means that investment in ELSS funds can build your financial future while savings taxes.
ELSS can be the best retirement planning investment for young investors
For retirement planning in India, Public Provident Fund (PPF) is a very popular investment and probably the first choice of the investors. However, ELSS can be a much better choice. Let us understand this through an example as to how much wealth would have been created in the last 15 years by investing in ELSS versus PPF.
Let us assume Anil has invested Rs 70,000 in FY 2000-2001, Rs 100,000 from FY 2001-2002 to FY 2013-14 and Rs 150,000 in FY 2014-15 (these are the Section 80C maximum limits for respective financial years). Anil would have invested Rs 15.20 Lakhs over this duration of 15 years in PPF. After 15 years the maturity value of Anil’s PPF account would have been Rs 29.80 Lakhs.
Now, let us assume Tarun has invested the same amount by availing the maximum limits in respective years in ELSS Funds. Tarun would have accumulated the same amount i.e. Rs 15.20 Lakhs over the duration of 15 years. The value of the investments in ELSS Funds after 15 years is over Rs 1.15 Crores (We have chosen an ELSS scheme which has completed over 15 years and generated an internal rate of return of 20%), which is over 3.5 times more than that of PPF investments.
In fact, the value of the two investments made in the year 2000 and 2001 at the end of the 15 year period itself is much higher than that of the total PPF corpus after 15 years.
As we can see the ELSS returns are of a very different order of magnitude compared to PPF investments. As such the ELSS investments are one of the best options for retirement planning as far as young investors with long term investment horizon are concerned.
Tax Benefits of ELSS
Equity Linked Savings Schemes (tax saver mutual funds) are also the most tax friendly investment schemes as there is no taxation during the investment period, unlike many traditional tax saving investment options. Since ELSS funds are equity oriented mutual fund schemes with a minimum investment period of 3 years, the long term capital gains from ELSS Schemes are tax-free. Dividends paid by ELSS Schemes are also tax-free. Therefore, returns from Equity Linked Savings schemes, are completely tax-free in the hand of the investor – In the form of capital appreciation as well as dividends.
Conclusion
In this article, we discussed how Equity Linked Savings Schemes (tax saver funds) is the best tax saving option which also helps you create wealth over a long period of time while saving taxes. Investors should note that Equity Linked Savings Schemes are market linked investments and therefore can be volatile in the short term and therefore, they should be patient and have a sufficiently long investment horizon for investing in Equity Linked Savings Schemes. Young investors with a long term investment horizon can use ELSS investments for meeting their long term financial goals like retirement.