ELSS : A Sensible Choice For Your Tax Planning Needs
Nov 08, 2019

Author: Aditi Murkute

ELSS v/s Tax Planning: Which Is the Sensible Choice for Tax-Saving This Year?
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Last weekend, a friend, Pooja and I met for lunch. After casual pleasantries, she said, "Aditi! I want to know more about mutual fund investments, as I read the Diwali bonus article. I even am looking for options to save tax."

I asked, "Have you heard of ELSS?"

"No! What is it?", Pooja replied.

Equity Linked Saving Scheme (ELSS) is an equity mutual fund scheme that invests a predominant portion of their net assets in equity and equity-related instruments. Most ELSSs hold a diversified portfolio and usually are market-cap and sector agnostic.

In layman's term, ELSSs aren't normally skewed to a particular market capitalisation segment large-cap, mid-cap, and small-cap or sector. In terms of investment style, ELSS may be of any genre. The fund may follow a growth or value style or even a combination of both.

It is one such category of Mutual fund scheme that has a dual role to provide tax benefits and grow wealth over a long period of time. Hence, it is also known as a Tax Saving Fund as it qualifies for tax exemption under Section 80C of the Income Tax Act.

But remember, ELSS has a mandatory lock-in period of three years among a galore of tax-saving investment avenues viz. Public Provident Fund (PPF), National Saving Certificate (NSC), Pension Funds, National Pension System (NPS), 5-Year tax saver deposits and the returns clocked by some ELSSs over the long-term (3 years and more) indicate, that they're not only advisable for tax planning under Section 80C, but even addresses your long-term financial goals. So, effectively by investing in ELSS, you could hit two birds with one stone.

Yet ELSS does carry a high risk as it invests predominantly into the equity, so be mindful about the fund that you add to your portfolio. In terms of risk -return trade off, ELSSs are placed midway between value/contra funds and Focused funds.

Graph: 1 Equity funds: Risk-Return trade off

Graph: 1 Equity funds: Risk-Return trade off

It is important to choose an ELSS that has consistently performed and comes from a stable of mutual fund house that follows robust investment process & systems with effective risk management strategies in place. Because if you pick the wrong fund, you will have to bear the cost of underperformance for the entire period of mandatory lock in of three years, so you should be extra cautious when investing in ELSS or any tax saving fund.

Although there are various funds available, the performance of each fund varies (over the years).

As seen below in the current market rally, some of the top ten schemes that have performed well consistently over 4 years or more.

Scheme Name Absolute returns CAGR
6 Months 9 Months 1 Year 3 Years 4 Years 5 Years
SBI Tax Advantage Fund 15.4 26.8 25.4 14.8 15.1 13.8
JM Tax Gain Fund 11.5 15.2 21.9 14.4 15.0 12.0
Quant Tax Plan 6.2 8.5 9.4 9.2 14.4 13.4
Axis Long Term Equity Fund 13.3 17.6 21.6 15.8 14.3 13.7
DSP Tax Saver Fund 8.9 16.0 20.3 11.9 13.9 12.4
Tata India Tax Savings Fund 8.0 11.7 19.0 12.7 13.8 14.2
HDFC Long Term Adv Fund 3.1 8.2 11.9 11.7 13.4 9.9
Invesco India Tax Plan 7.8 9.8 14.1 13.2 12.8 12.4
LIC MF Tax Plan 11.3 13.6 17.4 13.2 12.5 10.5
Kotak Tax Saver Fund 5.7 11.0 16.2 11.2 12.5 11.5
Average Category return 4.1 7.8 9.5 10.0 10.9 9.8
NIFTY 50 - TRI 5.5 9.8 14.9 13.7 12.3 9.0
NIFTY 500 - TRI 4.3 8.0 10.7 11.4 11.4 9.0
S&P BSE SENSEX - TRI 7.2 11.1 16.7 15.4 13.0 9.3

Data as on November 08, 2019
(Source: ACE MF)

*Please note, this table only represents the best performing funds based solely on past returns and is NOT a recommendation. Mutual Fund investments are subject to market risks. Read all scheme related documents carefully. Past performance is not an indicator for future returns. The percentage returns shown are only for indicative purposes.

The performance can vary over the years and it depends on how the fund manager has handled the portfolio both, in bull and bear market phases. Hence, do not base your investment decisions looking only at the past returns because that does not necessarily indicate that an ELSS will continue to fare in the same manner in the future.

Here are the key benefits of ELSS:

benefits of elss

The minimum application amount for most ELSS is as little as Rs.500, with no upper limit. However, do remember, only a sum up to Rs 1.50 lakh is eligible for deduction under Section 80C.

You can invest the entire amount at one go (as a lump sum investment) or via a Systematic Investment Plan (SIP) - a mode of investing in mutual funds in a piecemeal manner. In case you opt for the latter, do note that each SIP instalment will be subject to a three-year lock-in period.

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Graph 1: Growth of Rs 10,000 if invested in Mirae Asset Emerging Bluechip Fund 5 years ago

Nevertheless, SIP is a worthy route to invest in mutual funds regularly and systematically and inculcates a sense of discipline towards your personal finances. Further, SIP helps to reduce the shocks of a volatile equity market vide rupee-cost averaging and at the same time helps you compound wealth over a long period of time.

[Read: Best SIPs To Invest in 2019]

Do note that aim to maximise tax-saving as well as wealth creation. In the long-term, ELSS or tax-saving funds have displayed their potential to clock luring inflation-adjusted returns. The returns generated by some worthy ELSSs reflect that not only are they worthy for tax planning, but they can even help meet your financial goals.

Finally, when you invest in ELSSs, make sure you have an investment time horizon of at least 3-5 years.

Do not invest in an ad hoc manner, it would be far more meaningful if you select tax-saving investments after understanding all the features and in accordance with your risk appetite. It is a risky proposition, so consider investing in an ELSS only if you have a long-term investment horizon.

Pooja thanked me for this information. Our food was served, and we enjoyed our meal and continued our usual chatter.

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benefits of elss

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