Are You a Risk-Taker Looking for Tax-Saving Investments? Consider Investing in the Best ELSS

Jan 19, 2022

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Tax-saving season has arrived; we are now in the final quarter of FY2021-22. Many of you are probably looking for tax-saving investment options to preserve your hard-earned money, but may not have an effective tax-saving plan in place.

Ideally, the best time to start planning your tax-saving investments is at the beginning of financial year. However, most taxpayers procrastinate on their tax-saving plan till the last quarter of the financial year. This approach usually results in poor investment decisions and an accumulation of schemes that can be detrimental to your portfolio. In this article we help you understand the best Equity Linked Saving Schemes (ELSS) that could help you save on taxes this year.

Tax planning is a crucial task in financial planning whereby you can reduce your tax liabilities by investing in approved tax-saving instruments. An effective tax plan involves sifting through the various tax-saving instruments that are eligible for deduction under section 80C of the Income Tax Act, 1961, and choosing the most suitable option aligned with your financial plan. You simply need to understand the fundamentals of these financial instruments and invest wisely.

Recently, a friend of mine Rahul called and said, "Mitali, as you know there are hardly few months left to finalise tax-saving investments for this financial year. I am aware of the traditional tax saving schemes, but I need your help to choose a suitable tax-saving investment option that can provide decent returns as well."

To which I replied, "Sure Rahul, before we start discussing suitable tax-saving instruments, we need to assess your risk profile, whether you are a risk-taker or risk-averse. This will help us choose the tax-saving instruments in line with your risk appetite that will assist you to fulfil your tax saving requirements. Remember all investments are subject to market risk"

Rahul queried, "How do we select the best tax-saving instruments based on the risk profile? Could you please explain it to me in detail?"

Are You a Risk-Taker Looking for Tax-Saving Investments? Consider Investing in the Best ELSS
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You see, investing in a tax-saving avenue based on your risk profile is essential for every taxpayer because it will lead to constructing an effective tax-saving plan. Given the uncertainty surrounding the pandemic, many people have had financial difficulties, such as job loss, salary reductions, and other factors that may have altered one's risk tolerance. It is wise to invest in tax-saving instruments only after reassessing your risk profile.

In my view, instead of investing in an ad hoc manner, choosing a tax-saving investment option/s based on your risk profile can be a significantly valuable addition to your investment portfolio. This could even assist you to achieve your envisioned financial goals.

If you are a risk-averse investor that prioritises capital preservation over the potential of a higher-than-average return, then you may stick to traditional government backed tax-saving investment avenues. These include Public Provident Fund (PPF), National Savings Certificate (NSC), National Pension Scheme (NPS), and Unit Linked Insurance Plan (ULIPs) which offers a conservative plan for risk-averse investors that wish to invest in debt instruments only.

Under section 80C of the Income Tax Act, 1961, all of these tax-saving instruments are eligible for a tax deduction of up to Rs 1.50 lakh per year. High-risk investments, such as equities or market-linked securities, are generally avoided by risk-averse investors.

Given that, if you are a risk-taker who is an aggressive market investor and have the capacity to stomach the market risk, then you could consider market-linked tax-saving instruments. Risk takers are intrigued from the market volatility, viewing it as an opportunity to realize a higher return on their investments and they are classified as below:

  • Risk takers are generally young at age with a long investment horizon

  • Have a high income and are in the process of owing considerable assets

  • They hold limited liabilities and have less dependents to support

  • They are willing to stomach the risk and achieve their envisioned long-term financial goals

Risk-takers may consider investing in the best ELSS and gain tax benefits with potentially optimal returns. As compared to traditional investment options like Fixed Deposits and National Saving Certificate (NSC), etc., ELSS offers higher returns.

So what is an Equity Linked Savings Scheme (ELSS)?

ELSS is a type of diversified equity mutual fund scheme and works like any other open-ended equity fund. As per SEBI's norms, an ELSS invests a minimum of 80% of its asset in equity and equity related instruments. Plus, ELSS investments qualify for tax exemption under section 80C of the Income Tax Act 1961, so you can claim tax exemption up to Rs 1.5 lakh per financial year.

Over the last decade, ELSS or Tax Saving Mutual Funds have outperformed all other traditional tax-saving instruments. This indicates that an investment in the best ELSS will be beneficial for taxpayers who are willing to take the risk and can tide over market volatility.

Why risk takers can consider investing in ELSS?

ELSS is the only category of mutual funds eligible for tax deductions under section 80C of the Income Tax Act, 1961. In the long-term, if you intend to create wealth, ELSSs have the potential to clock attractive inflation-adjusted returns.

As we mentioned earlier, ELSS invests primarily in equity instruments, and the returns are substantially higher than most other tax-saving investment options in the long run. This accomplishes two goals: you save money on taxes while simultaneously generating significant returns. Investing in the best ELSS might be a good way to save taxes for a risk taker who is willing to invest for the long term.

Another advantage is, ELSS offers lowest lock-in-period of three years compared to other traditional tax-saving instruments. Although ELSS has a lower lock-in period, it is advisable to consider it as a long-term investment and hold for a period of at least 5-7 years for better returns. The equity market may be volatile in the near term considering the current headwinds in play, such as the rapid rise in cases of omicron new variant of coronavirus and the US federal reserve's announcement of reduction of stimulus. Thus, it is prudent to invest in ELSS with a long-term approach.

Taxpayers have the option of making lump-sum deposits or investing in mutual funds through a Systematic Investment Plan (SIP). We do recommend investing via the SIP mode because it allows you to invest a predetermined amount at regular intervals, regardless of market conditions, in order to create a desired corpus over a longer period of time. Bear in mind, if you invest through a systematic investment plan (SIP), each instalment is locked-in for three years.

Investing in the best ELSS is an ideal way to begin tax saving with mutual funds and enter the equity market. Generally, novice investors begin by investing in these best ELSS before moving on to vanilla equity mutual fund schemes. In addition, an ELSS provides risk-takers with the opportunity to observe and become accustomed to market volatility as an investor. It helps build discipline since you cannot redeem the fund during the lock-in period of three years and have to stay invested for a long term.

The tax efficiency of ELSS is such that the gains you make from equities are considered long-term capital gains (LTCG) if redeemed after one year of investing. LTCG on equities up to Rs 1 lakh in a financial year is tax-free; however, LTCG more than Rs 1 lakh in a financial year is taxed at 10%.

Being a market-linked tax-saving instrument, ELSS not only reaps the rewards of market highs, but also has provisions in place to mitigate the negative impact of market lows and curb the downside. When compared to other equity investments, the best ELSS mutual funds have proven to be considerably less volatile.

Notably, ELSS funds offer different investing strategies; keep in mind that the market risk associated with ELSS portfolios may vary across such funds. Those taxpayers with a moderate to low-risk appetite could choose ELSS funds with a large-cap bias; while those with a higher risk appetite can opt for ELSS funds with a multi-cap approach or mid/small-cap biases.

How to select the best ELSS to invest in 2022?

When deciding on the best ELSS, evaluate the various quantitative and qualitative parameters and compare the fund's performance to that of its peers. This will confirm how consistent its performance has been in the past and indicate if the fund house follows robust investment processes and systems. As a word of caution, do not be influenced merely by the returns; there's more to evaluating the best ELSS mutual funds and past performance does not guarantee future returns.

The success of an ELSS is totally dependent on market fluctuations and the decisions of the fund's management. As a result, seek a fund with a consistent track record, as well as other qualitative factors, such as the fund house's pedigree, investment approach, and the competence of the fund management team.

[Read: 3 Best ELSS for 2022 - Top Performing Tax Saving Funds to Save Tax in 2022]

For a risk taker, several worthy tax-saving investment avenues are available, but ELSS is a superior option that will assist you in effective tax planning and long-term wealth creation.

Here's list of the best ELSS you can consider to invest in 2022:


To conclude...

If you are a risk taker and can stomach the risk of market fluctuations, an ELSS investment can fetch you significant returns as well as serve your tax saving needs. Amid the pandemic last year, the March 31st deadline for tax-saving investments was extended. The looming threat of omicron variant has once again raised concerns amongst tax payers about another extension of the deadline.

As mentioned earlier, you should avoid leaving your tax planning for the eleventh hour. We strongly recommend not waiting for an extension on the tax filing deadline. After assessing your risk profile, it is advisable to make prudent tax-saving investments in the best ELSS as early as possible to save taxes in 2022.

If you want to save yourself from the last-minute stress and initiate your tax planning with worthy tax-saving investment schemes, subscribe to PersonalFN's premium research service, FundSelect. It offers super comprehensive and detailed research reports on the best ELSS or Tax Saving Funds and other diversified equity mutual funds.

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Warm Regards,
Mitali Dhoke
Jr. Research Analyst


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