Most taxpayers are considering various tax-saving investment options as they approach the last quarter of the fiscal year. However, with limited financial literacy and several options available under section 80C, investors often end up investing in suboptimal tax saving options that generate lower returns with limited liquidity.
Today, let’s take a close look at ELSS funds and understand how they offer a better tax saving option than others:
Lowest blocking period
Of all the section 80C options, ELSS comes with the lowest lockout period of just 3 years. Other investment options eligible for Section 80C deductions like ULIP, NSC, Tax Saving FDs come with a 5 year lock-in period. Meanwhile, the PPF comes with a 15-year lock-in period, while the NPS remains locked-in until retirement with very limited options for early withdrawals. Thus, ELSS funds offer the highest liquidity among all investment options eligible for section 80C deductions.
Higher potential for wealth creation
Being diversified equity funds, ELSS invests primarily in equities and instruments linked to equities of all market capitalizations, sectors and themes. As equities as an asset class largely beat fixed income instruments and inflation over the long term, ELSS funds may generate higher returns than other Section 80C fixed income instruments such as NSC. , Tax-saving bank PPF, FD, etc. A 3-year lock-in period in ELSS also reduces redemption pressure on their fund managers, allowing them to have a longer-term view of the market than other open-ended funds. All of these features combined make ELSS funds an excellent instrument for wealth creation and the achievement of long-term financial goals like building corpora for life after retirement, higher education for children, etc.
Tax-free returns on LTCG less than 1 lakh
Capital gains realized on shares repurchased after 1 year of investment are considered as long-term capital gains (LTCG). LTCG on shares up to Rs 1 lakh in a fiscal year is tax exempt, while LTCG over Rs 1 lakh in a fiscal year is taxable at 10%. Among the other investment choices in Section 80C, the PPF has tax-exempt maturities, while the interest earned on tax-saving FDs and KVP is taxable according to the investor’s tax regime. For ULIPs, the entire proceeds of the due date are taxable if the premium paid exceeds 10% of the sum insured.
Instills financial discipline
Like other categories of mutual funds, fund companies allow the SIP mode of investing in ELSS. SIP allows you to invest a predetermined amount at regular frequencies regardless of the market situation to build a desired corpus over the period. This periodic and automatic deduction of the investment encourages you to save as well as to invest regularly. By spreading your investment over a longer period, SIP allows you to benefit from an average cost in rupees during market corrections and dips.
Factors to Consider Before Investing in ELSS
# Analyze your risk appetite
Since ELSS funds have different investment strategies, the market risk of ELSS Portfolios may differ from one ELSS fund to another. Thus, those with a moderate to low risk appetite should opt for ELSS diets with a large cap bias. Those with a high risk appetite can opt for ELSS funds following a Multicap strategy or mid / small cap bias.
# Compare their past performance
When choosing ELSS funds, be sure to compare their performance over the last 3, 5 and 7 years. Although great performance in the past may not guarantee similar performance in the future, comparing funds helps to discover how the fund has handled various economic conditions in the past relative to peer funds and benchmarks.
# Avoid opting for the dividend option
Many investors mistakenly perceive dividends from mutual funds as windfall income. What these investors don’t understand is that the dividends declared by the funds are the money paid from their own investment. As a result, the net asset value of the fund is deducted from the money paid out as a dividend. In addition, dividends received by investors are taxed according to the investor tax base. Therefore, investors should go for the growth option in the ELSS fund and benefit from the power of compounding.
# Opt for ELSS direct plans
The expense ratios of direct plans are typically up to 1% lower than those of their regular counterparts. As the direct plans of UCIs do not entail distribution costs, the savings made in this respect remain invested in the direct plans. These savings themselves start to generate returns through the compound effect, thus generating higher returns than the regular plans. Although the difference in yield might seem small in the first few years, the difference would become substantial in the long run.
(The author is director, Paisabazaar.com)