There are various investment options available in the market for tax saving. However, ELSS beats all other tax-saving options. Here's why.
The onset of the last quarter of the financial year starts the mad rush towards various tax-saving investments available under Section 80C. However, with multiple tax-saving instruments to choose from and very little time spared for comparing them, most investors end up with instruments offering sub-optimal returns and low liquidity.
Here are the main reasons why Equity Linked Savings Scheme (ELSS) beats others as the best tax-saving option:
Why ELSS beats all other tax-saving options
1. Highest returns
As ELSS schemes primary invest in equities, their returns would primarily depend on the performance of their portfolio constituents. While equities as an asset class can be very volatile in the short term, they outperform other asset classes, especially fixed-income products like debt mutual funds, fixed deposits etc., by a wide margin over the long term. Investors with a long-term horizon can easily expect at least 12% annualised returns from ELSS.
For instance, ELSS as a category generated an average annualized return of about 16% and 17% p.a. over the last 5-year and 10-year periods. Some of the top performing ELSS funds like Aditya Birla Sun Life Tax Relief 96, ICICI Prudential Long-Term Equity Fund and Franklin India Tax Shield have delivered higher annualized returns of over 19%, 20% and 18% over the last 10-year period, respectively.
2. Shortest lock-in period
ELSS schemes have the lowest lock-in period of 3 years among all Section 80C options. Among other Section 80C options, ULIPs, tax-saving fixed deposits and National Saving Certificate (NSC) have lock-in periods of 5 years whereas PPF has a lock-in period of 15 years. National Pension Scheme (NPS) investments stay locked-in till your retirement. Thus, ELSS offers the best liquidity among all Section 80C schemes.
3. Tax-free returns and maturity proceeds
Prior to this financial year, ELSS used to fall under the EEE (exempt-exempt-exempt) category. The investment amount, maturity proceeds and dividend income were entirely tax-free. However, the Budget 2018 brought ELSS gains under the ambit of long-term capital gains (LTCG) tax net by taxing its LTCG along with those of other equity and equity-related instruments exceeding Rs 1 lakh per financial year @ 10%. As the LTCG of less than Rs 1 lakh remains tax-free, ELSS investments for most individual investors are likely to remain tax free in practice. Among Section 80C options, only PPF and ULIP offer tax-free maturities. However, the entire maturity proceeds of ULIPs would become taxable if the premium paid exceeds 10% of the sum assured. Among other Section 80C options, interest earned on NSC and tax-saving fixed deposits from banks and post office are taxed according to the investors’ tax slabs.
4. Instills financial discipline
As with other mutual funds, ELSS schemes allow investing through the Systematic Investment Plan (SIP) mode. SIP allows one to spread his investment across several months or even years, which helps in averaging the investment cost during market dips and corrections. The automatic deduction of investment enforces regular savings and investment.
Points to remember while investing in ELSS
# Compare their past performance: While selecting your ELSS scheme(s), ensure to compare the performances of various ELSS schemes over the last 3-year and 5-year periods. While past performances cannot guarantee similar performances in the future, comparing different ELSS schemes will depict how they dealt with the rising and falling markets.
# Don’t opt for the dividend option: Mutual fund dividends are often projected as windfall income. However, what many investors fail to realize is that dividend amount is paid out of their own investment. As a result, the fund’s NAV too gets reduced by the dividend amount. Instead, opt for the growth option to benefit from the power of compounding.
# Opt for the direct plan: The expense ratios of ELSS direct plans are usually lower than regular plans by up to 1%. The savings generated from lower expense ratios would remain invested in your ELSS scheme, which in itself would start to generate returns. While the difference in returns might seem nominal during the initial years of investment, it will become significant over the long term due to the power of compounding. For example, a monthly SIP investment of Rs 10,000 for 25 years with an annualised return of 12% and expense ratio of 2% will generate a corpus of Rs 1.25 crore. The same investment for the same tenure and rate return but with an expense ratio of 1% will generate a corpus of around Rs 1.50 crore, thereby outperforming the other corpus by Rs 25 lakh.
(The author is CEO & Co-founder, Paisabazaar.com. This is his personal view. Please consult your financial advisor before investing in any scheme.)