January 10, 2020 2:09:41 pm
It’s the final quarter of the financial year – when most of India starts tax-planning and buying tax-saving investments and insurance products. For those on the lookout for a solution to their investment and tax-saving needs, I have the following advice: invest in a good ELSS fund. Not only will you save taxes under Section 80C, but, judging by past performance, you’ll also give yourself a better chance of creating wealth.
Equity Linked Savings Schemes are diversified mutual funds, the only kind of mutual fund which allows tax deductions. As the name suggests, ELSS funds invest in the stock market. With a three-year lock-in, investors remain invested for the long-term and thus give themselves a better chance of riding out the cyclical ups and downs of the markets. You can buy ELSS funds directly from the websites of any fund house, or through online distributors, aggregators and agents.
But why should you invest in any stock market-linked investment, especially in a volatile time such as this? Let’s look at the benefits of investing in ELSS, and also understand the risks.
Better returns than traditional tax savers
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The go-to tax-saving investments of the common man are the Employees Provident Fund, the Public Provident Fund, National Savings Certificate and the traditional endowment policy. As of today, PPF and NSC return 7.9 per cent per annum. The EPF returns a much better 8.65 per cent, which is excellent given the current situation in the market. The returns from the maturity proceeds of endowment plans are comparable to, or lesser than, returns from bank deposits. However, they have long lock-ins, and premature liquidation penalties.
In comparison, the ELSS marketplace of 35 funds listed by AMFI has one-year returns of 8.17 per cent. Among those 35 funds, 15 have delivered returns over 10 per cent, and 21 have delivered over 8 per cent over the last year. Only one fund had negative one-year returns.
If you take a long-term view of these funds, the returns look even more impressive. If you consider a five-year period, 23 of the 29 available funds have given returns over 8 per cent per annum, and none had negative returns. Over a 10-year period that includes 26 available funds, 24 delivered above around 9 per cent per annum or more. Over a 15-year period, of the 14 available funds, the lowest returns by any fund is 9.89 per cent per annum.
Past returns are no guarantee of future performance. However, for the sake of illustration, let’s further understand what the returns could translate into over the long-term. Suppose you invest Rs. 1.5 lakh every year in PPF for its full tenure of 15 years. At the current rate of return of 7.9 per cent per annum, you can hope to create an assured corpus of around Rs. 43 lakh. However, a monthly SIP of Rs. 12,500 for 15 years will provide you Rs. 52.2 lakh assuming an annual rate of return of 10 per cent.
Assuming the same rate of return, no further investment, and the three-year lock-in after the 15th year, your corpus would be Rs. 69.5 lakh, out of which your Long Term Capital Gains will be approximately Rs. 47 lakh. Under the current tax rules where equity Long Term Capital Gains over Rs. 1 lakh are taxed at 10%, you can still net around Rs. 63.5 lakh, tax-free, in the 18th year. Alternatively, you can liquidate your fund units as and when they turn three years old, though this would deny you the power of exponential, compounded growth in the later years.
Ease of investment and risks
ELSS schemes are easy to access. Most schemes allow you to invest a minimum of Rs. 500 per month via SIPs. You can also make lump-sum investments as per your requirement without any upper limit, though tax exemptions can be availed only up to Rs. 1.5 lakh. After making the minimum number of mandatory investments (typically, six investments of a minimum of Rs. 500), you have the option of continuing or discontinuing the investment plan.
Unlike small savings schemes such as the PPF or Sukanya Samriddhi Yojana, you do not need to keep making the minimum mandatory investments every year. Once the investment is made, you need to remain invested for three years, after which the decision to remain invested or to liquidate is yours.
That being said, before you invest in ELSS or any equity mutual fund scheme, understand the risks and costs of investment. The risks include the fact that this is an equity investment and is therefore subject to the usual risks associated with the stock market.
There are ways to lower your risks. You could buy a well-diversified fund that invests in a variety of companies and sectors. And instead of making large, lump-sum investments, you could take the SIP route which provides the advantage of rupee cost averaging and allows you to exploit the rise and falls of the stock market. Also, picking a fund managed by someone with a proven track record for performance is advisable.
Lastly, look at the investment costs. Any ELSS fund will have a regular plan and a direct plan. For seasoned and aware investors, it’s advisable to invest via a direct plan which has a lower commission structure and hence higher returns. If you’re a beginner, you may allow an agent or an online aggregator to help you select the right ELSS fund for you, with a marginally higher commission structure. This commission – part of the total expense ratio – typically varies from 1-3% depending on the plan or the fund.
Armed with this information, you should be able to figure out your year-end tax-saving plans. But hurry – there’s not a lot of time left in the year. And when in doubt, consult an investment advisor.
The author is CEO, BankBazaar.com. The article has been published in collaboration with BankBazaar. Opinions expressed are those of the author.
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