‘A penny saved is a penny earned’, so goes a famous saying.
Since taxes can eat into your returns, tax-saving should form an integral part of every individual’s financial planning exercise. As a taxpayer, you have the option to select from various tax-saving instruments such as Public Provident Fund (PPF), National Saving Certificate (NSC), Tax Saver Bank FD, Equity-linked Saving Scheme, etc.
Out of the various instruments that offer a tax benefit, Equity-linked Saving Schemes (ELSS), also known as tax saving mutual funds, have gained immense popularity among taxpayers in the last decade. Individuals, as well as HUFs, can invest in ELSS or tax saving mutual funds and claim tax benefits.
SEBI defines tax saving mutual funds as open-ended equity schemes that come with a statutory lock-in period and tax benefit. These funds invest a minimum of 80% of their assets in equity and equity-related instruments and have the flexibility to invest across sectors and the market cap spectrum.
Here is why you should consider investing in ELSS or tax saving mutual funds for tax benefit:
1) Low lock-in period
ELSS or tax saving mutual funds come with a mandatory lock-in period of 3 years which is the lowest compared to other tax-saving instruments. This means you can redeem your investment as soon as 3 years from the date of purchase. National Savings Certificate (NSC) and tax-saving FD both have a lock-in period of 5 years. On the other hand, contributions to Public Provident Fund (PPF) are locked in for 15 years, while those towards National Pension System (NPS) are locked-in till the age of 60 years. So, if you do not want to commit money for a very long period, say 5 to 15 years or more, then tax saving mutual funds is an investment option you must consider. 2) High return potential
Being equity-oriented, ELSS or tax saving mutual funds have the potential to reap higher returns for their investors compared to non-market linked tax-saving instruments. Notably, the interest rates on non-market-linked tax-saving schemes such as Tax Saver Bank FD, PPF, and NSC are currently at a multi-year low due to RBI’s measures to support economic growth. Accordingly, most of these schemes are generating a very poor real rate of return.
Tax saving mutual funds invest in a diverse range of stocks/sectors/market caps depending on the market conditions to offer investors the benefit of capital appreciation. This makes ELSS a worthy avenue for earning inflation-beating returns over the long run.
3) Deduction under Section 80C
Unlike other equity-oriented schemes, ELSS or tax saving mutual funds offer tax-saving benefits to their investors. Investments of up to Rs 1.5 lakh in ELSS during a financial year are eligible for deduction under Section 80C of the Income Tax Act. Investors in the highest tax bracket can effectively save up to Rs 48,600 in overall tax liability by investing in tax saving mutual funds.
It is important to note that though there is no restriction on the maximum amount that you can invest in tax saving mutual funds or the number of schemes you can hold, the deduction under Section 80C is limited to Rs 1.5 lakh only.
4) Helps you ignore market noise
During uncertain and highly volatile market conditions, many investors rush to redeem their equity mutual fund investments. Since ELSS or tax saving mutual funds invest predominantly in equities, they too are susceptible to market ups and downs. However, the mandatory lock-in of 3 years helps investors to ignore the market noise and stay invested for the long term.
Staying invested for the long term allows you to mitigate the impact of market volatility on your portfolio. It also allows your wealth to grow with the power of compounding. Besides, the lock-in period allows fund managers of Tax saving mutual funds to take long-term high conviction bets without having to worry about redemption pressure.
5) Flexibility to invest systematically
ELSS allow you to invest a fixed amount regularly via a Systematic Investment Plan (SIP). Investment in ELSS through the SIP route can be done with a small investment amount of as low as Rs 500. Investing via SIP mitigates the impact of volatility on your portfolio vide the integral rupee-cost averaging feature and, in turn, potentially compounds your wealth. In addition, it inculcates a disciplined approach to investing, which is necessary for earning optimal returns from your mutual fund.
That said, remember that if you invest in tax saving mutual funds via the SIP route, each instalment is subject to a lock-in period of 3 years.
Investing in ELSS or tax saving mutual funds can maximise your wealth through a diversified portfolio of stocks and also provide tax benefits. If you are willing to earn inflation-beating returns and have an investment time horizon of at least 3 years, opt for ELSS or tax-saving mutual funds for tax planning this year.
As a category, ELSS or tax saving mutual fund returns have been impressive over the long term. The category has generated significant alpha over the benchmark indices, which makes it a suitable avenue for planning long-term goals.
Being an equity-linked product, ELSS can go through bouts of sharp volatility, and investment returns can see sharp fluctuations. However, they have the potential to outpace most other tax-saving instruments in terms of returns.
Finally, when you invest in ELSS or tax saving mutual funds, prefer the Direct Plan over the Regular Plan. The lower expense ratio of a Direct Plan can help you yield better returns over the long run.
(The author Christy Mathai is Fund Manager- Equity, Quantum AMC. Views are own)
(You can now subscribe to our ETMarkets WhatsApp channel)