Equity linked savings schemes (ELSS) have emerged as a very attractive tax saving option for Indian investors. Apart from saving tax, it also creates wealth in the long term. An ELSS has a 3-year lock-in period, which is much lower compared to other Section 80C products like PPF, NSC, long-term deposits, etc.

Tax break enhances post-tax returns

Let us assume that the net asset value (NAV) of an ELSS is R30. An investor who has R1,50,000 to invest under Section 80C can buy 5000 units of the ELSS scheme. If an investor is in the highest tax bracket, he will get an exemption of 30% (excluding surcharge and cess) on this investment.

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So, on an investment of R1,50,000, he gets a tax rebate of R45,000. Hence, the individual’s effective investment in the ELSS comes down to just R1,05,000. Let us further assume that at the end of three years the NAV has appreciated to R60. Therefore, the value of his investment has doubled from R1,50,000 to R3,00,000 in three years, or roughly 24% CAGR returns over three years.

The investor had received a tax rebate of R45,000 in the year of investment. Therefore, it is R1,05,000 that has grown to R3,00,000 in a span of three years. So effectively, in post-tax terms, his money has not just doubled but has almost tripled via the ELSS route. That is the big difference that a tax break can make for an ELSS investment. ELSS currently enjoys the tax benefit of being exempt, exempt, exempt (EEE).

ELSS tends to outperform normal equity funds

At a personal portfolio level, it has been observed that ELSS funds tend to outperform normal diversified equity funds, although both funds invest in the same asset class. There are two possible reasons for the same. Firstly, an ELSS has a three-year lock-in period. This infuses a certain degree of investing discipline. Secondly, since a chunk of the funds are locked in, the fund manager also has the leeway to take more long term decisions.

Adopt a SIP approach to ELSS

Most investors pay their taxes at regular intervals but plan for their tax-related investments towards the last quarter of the year. It may actually make more sense to align your tax-related investment strategy to your regular tax outflows. When you spread your ELSS investment over the full year, it gives you two distinct advantages. As your purchases are phased, it does not put undue pressure on your liquidity situation. Secondly, this gives you the benefit of rupee cost averaging. Buying your entire quota of ELSS at one point of time may mean that you may be missing out on the best price. An SIP approach automatically ensures that you get as close to getting the best price as possible. Over a long period of time, that reduces your effective cost and enhances the yield on your ELSS investment.

The writer is head of research, Angel Broking