Equity-linked savings schemes (ELSS) are tax-saving financial instruments and offer tax benefits under section 80C of the Income Tax (IT) Act. Such funds invest a majority of the corpus in equities to deliver capital appreciation.
Why ELSS Mutual is Funds the Best Tax-Saving Option?
Investing in ELSS mutual funds comes with the dual benefit of tax deductions and wealth accumulation over time. ELSS mutual funds have a lock-in period of just three years, the shortest among all tax-saving investments and have the potential to offer the highest returns among 80C options.
Benefits of ELSS Mutual Funds
The benefits of investing in an ELSS mutual fund are:
- Tax Saving – This is indeed the primary benefit of investing in equity linked savings scheme plan. An amount of upto ₹1.5 lakhs is available for tax deduction per financial year under Section 80C of the Income tax Act, 1961. An ELSS mutual fund is the only mutual fund where you can claim tax deductions.
- Lock-in Period – ELSS mutual funds come with a mandatory lock-in period of 3 years in comparison to 5 years or more with respect to other tax saving instruments. PPF comes with a lock-in period of 15 years. Also, an ELSS mutual fund provides the highest returns with the lowest lock-in period.
- Long Term Capital Gains Tax – Returns in an ELSS mutual fund post the three year mark are considered as long term gains. Gains above ₹1 lakh are taxed at the rate of 10% under LTCG tax.
- Compounding – When you stay invested in an ELSS mutual fund for a period of 5-7 years, not only are you inculcating a disciplined habit of savings, your investment is also subject to the power of compounding.
- Higher Returns – ELSS mutual fund invests primarily in equity funds. Equity funds have a higher rate of return (15%-20%) in comparison to other tax saving options (7%-10%).
Why you should invest in ELSS?
There are various tax savings options available out there under section 80C of the Income Tax Act, equity-linked savings schemes (ELSS) have emerged as one of the most popular options. ELSS is a tax-saving mutual fund with a three-year lock-in period, where investments are made in equity-related instruments. For long-term investors, choosing ELSS over other 80C products like PPF and NSC is more beneficial from a wealth creation perspective.
Tax Benefit under Section 80C
As said before, your investments in ELSS are eligible for a tax deduction of up to Rs 1.5 lakh from your gross total income under Section 80C of the Income Tax Act. Though you can avail a maximum tax deduction of only Rs 1.5 lakh under the section, there is no limit on the amount you can invest in these schemes.
Being linked to equity, ELSS funds can give inflation-plus returns in the long term. While returns are not guaranteed, historically, we have seen that over longer periods of 7-10 years, equity portfolios are consistently able to deliver returns which beat inflation by a reasonable margin. Fixed-return products like savings certificates or fixed deposits are less efficient at doing this over the long term. Those are more oriented to giving income rather than creating wealth.
Lowest Lock-In Period
All tax saving investments typically comes with a mandatory lock-in period. For example, PPF comes with a 15-year lock-in period. Tax-saving term deposits have a lock-in period of five years. ELSS comes with a lock-in period of three years. Though ELSSs come with a lock-in period of three years, invest in ELSSs with an investment horizon of at least five years in mind. This is just to be on a safe side as ELSS invests predominantly in stocks. And stocks are risky and volatile in the short term.
No Maturity Date
Most tax-saving investments such as PPF, tax-saving term deposit, among others, come with a maturity date. The PPF account matures in fifteen years and it can be renewed for another five years. An ELSS has no such fixed maturity date or period. You can continue to hold on to your ELSS investments as long as you wish.
Enabled for SIP
ELSS schemes have the SIP facility too that enables you to allocate smaller amounts every month rather than having to put in a lump sum. For those who earn a monthly salary, this is a useful option. However, keep in mind that each new instalment will have a separate date on which the three-year lock-in gets over. For long-term investors, this is not an issue as the investment can well be held for many more years.
If you are traditional investors who predominantly invest in tradition investments that come with assured returns, you should consider investing in ELSS to take a small exposure to equity. ELSS is considered ideal for first-time investors to enter the stock market. The mandatory lock-in period would help investors to weather the volatility typically associated with the stock market. In fact, you can devote your investments in ELSS for a specific long-term financial goal.
8 Mistakes to Avoid While Investing In ELSS
Here are the 8 common mistakes that investors make:
1. Timing the Market
2. Redeeming immediately after Lock-In Period
3. Lump Sum Investing
4. Never late is better
5. Avoid last minute Rush
6. Loving Large Investments
7. Not comprehending Fund Category
8. Investing only to Save Tax
Top ELSS Mutual Funds
1. Axis Long Term Equity Fund
- Axis Long Term Equity Fund was launched in 2009, it is today the biggest fund in the ELSS mutual fund category. The fund invests 65-70 percent of its money in India’s top 100 companies (also known as large caps), while 25-35 percent goes into mid and small cap companies.
- Return consistency is the hallmark of this fund. Since its inception, Axis Long Term Equity has managed to beat its benchmark nine out of 10 times. Although the fund has not seen a big market correction like 2008, it contained its losses well in falling markets of 2011 and 2018.
- The fund has delivered 14.93% average annual returns since inception while the 7-year returns are 16.05%
2. Mirae Asset Tax Saver Fund
- Aims at building a diversified portfolio of strong growth companies at reasonable price across market capitalisation, themes and investment styles
- Uses a bottom-up approach for stock selection driven by value investing in growth oriented businesses
- Investment decisions are based on broad analyses of the macro economy, business cycles and industry trends
- Prefers companies with high return ratios, robust business models and sustainable competitive advantages over their competitors
- Aims to invest in large base of stocks to avoid concentration risk
- Monitors the trading volumes of identified stocks before investment to avoid liquidity risk
3. Motilal Oswal Long Term Equity
- Follows an investment style and philosophy based on ‘Buy Right: Sit Tight’ principle
- ‘Buy Right’ refers to buying quality stocks at reasonable price
- ‘Sit Tight’ refers to remain invested for a longer time to realize the maximum growth potential
- Follows bottom-up approach for stock selection
- Uses a benchmark agnostic approach to build portfolio consisting of high conviction stock ideas and low portfolio churns
Believes in adequate diversification with less number of stocks
4. Canara Robeco Equity Tax Saver Fund
- Canara Robeco Equity Tax Saver Fund is one of the oldest funds in the ELSS fund category. It was launched in 1993, and invests most of its money in India’s top 100 companies.
- Canara Robeco Equity Tax Saver has an amazing downside protection capability, and it has managed to beat its benchmark and also the category average in 2008, 2011 and 2018, i.e. all three major market corrections. In fact, in 2018, when the average returns of the entire ELSS mutual fund category was running in the negative, this tax-saving mutual fund delivered positive returns.
- It’s returns since inception are 13.55% while its seven-year returns are 10.27%
5. Nippon India Tax Saver
- Aims at generating sustained long term growth.
- Offers optimal mix of defensive and cyclical themes.
- Investment philosophy as of May 2020 —
- Maintains balance between large cap and mid cap
- Invest in companies high growth prospects over the medium term (2-3 years.
- Takes 2 or 3 sector calls at a time in line with emerging market trends
- A small proportion is invested in contrarian calls
- Significant exposure to MNCs and high conviction mid-cap companies
6. DSP Tax Saver
- Uses multicap strategy of investing with a longer investment horizon
- Seeks portfolio diversification across sectors and styles to create a durable portfolio
- Invests in established and emerging businesses to provide a combination of stability and growth
- Follows a combination of top-down sector allocation and bottom-up stock selection approaches
- Uses a blended analysis of valuation support and growth drivers for stock selection
- Constantly monitors future prospects and price targets for investment decisions