Why ELSS is Best Tax Saving Option than PPF, NSC & Bank FD

ELSS (Equity Linked Savings Scheme) is the only investment product that offers twin advantages of Tax Benefit & gets an opportunity to gain the best Equity Returns.

ELSS tax saving and wealth creation

ELSS Twin Benefits Tax & Equity


Here is the summary of the article.

About ELSS
What is ELSS?
ELSS – Comparison
ELSS Comparison with PPF, NSC and Bank FD
Why ELSS?
Why should you choose Equities for excellent returns?
India – Why Invest in Equities
Advantages to Fund Manager
SIP in ELSS
Recommended Schemes
Summary


What is ELSS?

An ELSS is a type of diversified mutual fund scheme that invests in equity & equity-related securities with a lock-in period of 3 years. This enables the investors to benefit from the long-term growth potential of the equities.

ELSS mutual funds schemes are qualified for tax exemption under section 80C of the Income Tax Act 1961, where the investments up to Rupees 1.5 Lac* is eligible for deduction from your total taxable income.

ELSS Comparison with PPF, NSC and Bank FD –

Let’s see expected returns & Lock-in period for various investment avenues. These figures are updated as on 21st May 2016.

Comparison ELSS Vs Other Assets

Expected Returns ELSS Vs Other Investments

* – There is no upper limit on investments. However, investments of only up to Rs.1,50,000 per year are allowed to be claimed as deductions under Section 80C of IT Act.
** – Historically ELSS have given 17-20% returns over the longer term.

Now let’s see what returns we can get after 20 years in above investment instruments.

ELSS returns in long term

Return of Rs. 1 Lacs Over 20 Years

As seen from above charts, returns of ELSS are too high (23.11 lacs) after 20 years than any other asset classes. We have considered average 17% returns; this value is subject to change per various fund schemes & market conditions. So you may get higher or lower returns at the time of withdrawal, but as you have seen these are higher than other investment classes over the long term.

ELSS returns

Graph – Return of Rs. 1 Lacs Over 20 Years

Why ELSS?

ELSS offers the following advantages over traditional tax saving investments

– Potential for higher returns (ELSS has given an average of 21.32% return in last 10 years)

– Lowest Lock-in period of 3 years in tax saving category

– Tax Benefit (Under I.T. Sec 80C)

– There is no limit on maximum investment amount

– Tax – Free Dividends

– No Long Term Capital Gains tax

– Choice of Assets Management Companies (AMC) & Schemes and also Options (growth / dividend / reinvestment)

– Convenience / Flexibility of investing (Lump sum / SIP / Switch / STP)

– You can begin investing with as low as Rs. 500\- amount.

Why should you choose Equities for excellent returns?

Equities (represented by BSE Sensex) have outperformed all other asset classes. In past 27 years, BSE Sensex has delivered approx. 20% returns yearly

Sensex returns

Sensex Returns Since Inception

India – Why Invest in Equities

8.5% GDP growth makes India amongst the fastest growing economies in the world. India presents fundamentals led growth story supposed to keep the pace high for at least a few decades.

Indian companies are very competitive – have growing cost-effectiveness, global outlook & plans, a confident management, etc. The Profit growth rates are very encouraging & are expected only to continue

As profits grow (between 15%-20%), the market would also grow at such a rate over the long term since the prices always trail the profits.

The market valuations are now fair, and stocks are not overvalued. For a long-term investor, the opportunity to create wealth over time is great.

Advantages to Fund Manager –

In ELSS fund manager gets longer holding period for the stocks, from which he get below advantages

  1. Time –
    • Longer period of holding equities
    • Due to longer period, you get benefits of Compounding
  2. Flexibility –
    • He gets good exposure to all type of investments depending on market condition
    • He can invest across all market cap
    • Liquidity

The resultant of this is investor gets Superior Returns in the long term, which obviously wants.

SIP in ELSS –

Investors can end up with many mutual fund schemes as they invest lump sums each year and pick the best performer.

Consider investing in Equity Linked Saving Scheme (ELSS) through systematic investment plans (SIPs). Many people invest lump sum amount in the month of March every year to avoid tax, but investing lump sum can be dangerous sometimes as market undergoes ups & downs. It may happen that market is in bull phase in the month of March & it goes in bear phase for next 1 year; here your returns will be lower. If you happen to invest in SIP, you get rupee cost averaging.

SIP options available in mutual fund schemes are always better for investing in the equity market in the long term. You get rupee cost averaging, which reduces the average cost and you get the advantage of the power of compounding.

Rupee cost averaging – Invest a specific rupee amount at regular intervals irrespective of the investment’s unit price. As a result, your money buys more MF units when the price is low and less units when the price is high, which can mean a lower average cost per unit over time. Rupee cost averaging allows you to discipline yourself by investing every month or quarter rather than making intermittent investments.

Keep in mind – there is a lock-in of 3 years, which means that every SIP installment will get locked for 3 years.

For example, if you choose to do a monthly SIP for a year starting 1st June 2016 and the last installment will be on 1st May 2017, the first installment’s lock-in period will get over in 1st June 2019, and the last installment’s in 1st May 2020.

Recommended ELSS Schemes:

I have written an elaborative post on How to Choose the Best Mutual Fund & Top 5 Best ELSS Mutual Funds. These will give you a systematic approach on how I have selected top performing funds. I recommend Axis Long-term Equity (Direct Plan -Growth Option) & Reliance Tax Saver (Direct Plan – Growth Option) for long-term capital appreciation. See 5 Best ELSS Mutual Funds

Summary

Investing in mutual funds is one the best step you are taking in your journey of becoming a great investor.

But given that this is an equity investment do factor in the risks involved. Don’t just go by the 3-year lock-in period, as a volatile market can lead to negative returns from ELSS funds in the short term. You must go in for the said investment only if you have other fixed income options in your portfolio which can provide a secure return. Also, spread your investments between ELSS plans of different fund houses. Axis, Franklin & Reliance are good options to consider.

2 Replies

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  1. Suneel says:

    Very well written article. This definitely shows us importance of investing in mutual funds and also get tax benefits under elss schemes.

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