Invest in ELSS Funds for Tax Savings & High Returns

The tax fever is back to haunt investors. While most Indians prefer traditional instruments that offer fixed returns, we believe market-linked options like the Equity Linked Savings Scheme (ELSS) that mutual funds offer, can be more lucrative over the longer-run. Lets look at benefits of ELSS vis-à-vis the regular tax saving options.

Higher inflation-adjusted returns

Traditional tax-saving instruments typically offer fixed returns, not commensurate with the high inflation prevalent in an economy like ours. For instance, assuming 6% rate of inflation, a fixed investment avenue promising a return of 8%, will offer a real return of merely 2%.

In comparison, ELSS funds invest in equities and thus, can generate higher inflation-adjusted returns over a longer timeframe. Investors can benefit from both, the potential upside of the equity market and a professionally managed, diversified portfolio. Long-term investments help set off the short-term volatility associated with equities. The CRISIL – AMFI ELSS Fund Performance Index - that represents the ELSS category - offered 15% returns over the last 10 years, vis-à-vis 8% returns given by traditional debt-oriented options. (See Chart 1 and table).

Chart 1: Performance of CRISIL – AMFI ELSS Fund Performance Index versus benchmarks

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Indices 1 year 3 years 5 years 10 years
CRISIL – AMFI ELSS Fund Performance Index5.520.310.515.3
Nifty 50-3.112.86.013.0
Nifty 5001.014.96.312.6
S&P BSE Sensex -4.312.95.912.9

Source: CRISIL Database *Returns as on October 30, 2015 and for period greater than one year are annualised

Equity investments for a young population

Indian population is known to allocate 59% of financial savings in safe fixed income instruments, while a negligible 3% finds way into equity-oriented assets (see chart 2). Now, given India's status as one of the youngest countries globally, this is indeed ironical. As per the State of the World Population 2014 report released by the United Nations Population Fund, 28% of India's people are aged below 24, despite being less populated than China. While this indicates that Indians have a long-term horizon, having equity-oriented assets will in fact help them generate an optimum corpus.

Chart 2: Components of household savings in 2013-14

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Source: RBI, * Of private corporates, banks, PSU and mutual funds

Other benefits of Investing in ELSS Funds

As per the Income Tax Act, an investment of Rs 1.5 lakh during a financial year qualifies for the tax deductions under section 80C.This helps investors in the higher inco​me tax bracket of 30% save Rs 46,350. Other prominent advantages of ELSS include:

  • EEEregime- ELSS falls under EEE (exempt-exempt-exempt) regime, which implies tax exemption at all three stages of contribution, accumulation, and withdrawal.  
  • Tax-free returns and dividend income - When investors liquidate their investments (after a three-year lock-in period), the returns generated are tax-free as they are classified as long-term capital gains. Further, the dividend payouts are also exempted from taxes as there is no dividend distribution tax on equity investments
  • Shortest lock-in period - ELSS funds have the lowest lock-in period (of three years), amongst all other tax-saving instruments - PPF (15 years), NSC and fixed deposits (5 years).  The lock-in period, on one hand, enables investors to harness fruits of long-term investing while on the other hand, saves fund managers from redemption pressures, and thus benefits the scheme.
  • Flexibility to take SIP route: Systematic Investment Plans (SIPs) help capture superior returns generated by equities and also minimise risks of investing in a volatile asset class. SIP is an easy, hassle-free and affordable way of investing in mutual funds, as it ensures regular investments at both high and low points of the market. It captures the opportunity, which is otherwise difficult to forecast, and averages the cost through rupee cost averaging and instills discipline.
  • SBI Magnum Tax Gain Scheme 1993 has outperformed its benchmark across all time frames. Further, the scheme has returned 17% and 13%, respectively, over seven and ten years ended October 30, 2015, surpassing the benchmark (S&P BSE 100) which offered 11% and 10%, respectively.​

​Additionally, investors' keen on receiving regular income can choose the dividend option. (However, these dividends are not guaranteed and declaration is entirely at the fund's discretion.) ELSS also gives investors the flexibility to start investing with a minimum amount of Rs 500, vis-à-vis Rs 5,000 for other equity funds.

Summing up

Unlike traditional tax-saving avenues, ELSS does not promise safety of capital, but has the ability to create wealth over the long run. Most importantly, irrespective of the asset class they choose, investors should comprehend that taxation plays an integral role in overall financial planning; hence, the activity should be carried throughout the year, an​​​​d not towards the end of the fiscal.

Please consult your financial advisor for more details on ELSS Funds.

Disclaimer :Any information contained in this article is only for informational purpose and does not constitute advice or offer to sell/purchase units of the schemes of SBI Mutual Fund. Information and content herein has been provided by CRISIL Research, a Division of CRISIL Limited, and is to be read from an investment awareness and education perspective only. The views / content expressed herein do not constitute the opinions of SBI Mutual Fund or recommendation of any course of action to be followed by the reader. Investors should consult their financial advisers before taking any investment decision

Mutual Fund investments are subject to market risks, read all scheme related documents carefully​​

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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