A Liitle Known But An Excellent Tax Saving Option - My Personal Favorite

All You Need To Know About Equity Linked Saving Scheme (ELSS)

Most of the people during the tax saving season (JAN-FEB-MAR) rush up for tax saving to invest upto 1 lac which qualifies for tax exemption under section 80C. And end up in paying LIC premium, PPF, NSC, 5 year bank FDs and other traditional tax savings instrument. Let us tell you one another option available: ELSS

What is ELSS?

ELSS - Equity Linked Savings Scheme is a type of mutual fund which is qualified for tax exemption under section 80C. Let’s dig into more information on this scheme.

  Ø  An ELSS is a mutual fund scheme that invests in equity and equity related securities.

  Ø  ELSS is just like a diversified equity fund in terms of their portfolio.

  Ø  They have a 3 year lock-in period.

  Ø  ELSS offers a tax deduction under section 80C upto investments of RS. 100000.

Advantages of ELSS over NSC and PPF

  Ø   Main advantage of ELSS is its short lock-in period of 3 years in comparison to any other tax saving instrument. Maturity period of NSC is 6 years and PPF is 15 years.

  Ø   Since it is an equity linked scheme earning potential is very high compared to PPF or NSCs.

  Ø  Investors who want periodic dividends can consider the dividend payout option under the ELSS category, wherein the dividends received are also tax free. In fact, this is the only investment option under Section 80C which provides interim cash flow during the lock-in period.

  Ø   Investor can opt for Systematic Investment Plan (SIP) rather than having to put money in lump sum.

Disadvantages of ELSS

  Ø   Risk factor is high compared to NSC and PPF.

  Ø  Returns are not guaranteed as these depend upon the market.

  Ø   Premature withdrawal is not allowed but it is allowed in other instruments in some specific conditions.

How can an investor buy ELSS from mutual funds? How is the return in the ELSS compared to other schemes like PPF and NSC?

ELSS could be open-ended or close-ended in nature. Majority of ELSS schemes are open-ended. This means they are open for subscription on all business days. As the name suggests, the scheme primarily invests in equity market by buying equity stocks of companies listed on the stock exchanges.

The units of the scheme are offered at the NAV (net asset value). The NAV is announced for all business days and keeps changing primarily depending upon the movement in the prices of stocks held in the portfolio of the scheme.

Equity as an asset class has given a higher return over the long term. ELSS has the potential to give substantially higher returns as compared to that from PPF or NSC over the long-term. The returns from PPF or NSC are in the range of 8 per cent and at times may not beat inflation.

Returns from ELSS could fluctuate depending upon the performance of the equity market and also the stock selection criteria of the particular fund manager. Returns from ELSS could even be negative in the short to medium term. As on 31st December, 2009, the average compounded annualised growth rate (CAGR) over 3 and 5 years period for the ELSS category of funds was 8.2 per cent and 20.1 per cent respectively. So ELSS is recommended for longer duration and SIP is the ideal method to invest in ELSS.

ELSS also scores over other tax-saving schemes since it offers tax-free return (long-term capital gains and dividends are totally tax-free as per the current tax structure). Only PPF offers tax-free return but it has a maturity period of 15 years.

What should be the criteria for choosing ELSSs offered by the different MFs?

The investor should apply the following criteria while selecting an ELSS for an investment:

Ø  The track record of the fund at least over the last 3 to 5 years. One should not attach too much importance to the recent 1-month or 3-month performance.

Ø  It is not necessary that the investor should select an ELSS based on its large size.

Ø  The discerning investor could also look at the portfolio of the scheme to ensure that it is well-diversified across market caps.

Ø  If the investment amount is more than Rs 20,000, then probably the investor could select two ELSS funds instead of one.

How much should one invest in ELSS?

The amount that needs to be invested in ELSS would depend on your risk profile as well as the other investments already committed towards PPF, EPF, insurance etc. A young investor with longer time horizon could use the entire limit of Rs 1 lakh for investing in ELSS if s/he is not investing in other tax-saving instruments under Section 80C whereas an aged investor could decide on a mix of three or four investment options. But, an investor should not ignore the ELSS option because this is the only option which has the potential of delivering higher returns.


Disclamier: This is not a recommendation. This is only for information use only. Please consult your personal financial advisor for the suitability of this or any other investment product. If you don't have a qualified personal advisor, please feel free to contact Your Financial Coach at satinder @yourmoneyyourway.in