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Mutual Fund ELSS schemes: best way to save tax and create wealth

May 30, 2017 by Dwaipayan Bose | 113 Downloaded
Picture courtesy - PICJUMBO

As recent as a few months back, more than one person told me that they would not have invested in life insurance policies for tax saving if they knew more about the return potential of Equity Linked Savings Schemes (ELSS). Despite considerable efforts made by the mutual fund industry on investor awareness over the years, the average person’s knowledge of mutual fund products is still quite low even in large urban centres like Kolkata.

Mutual fund Equity Linked Savings Schemes are among the best investment options for tax savings under Section 80C of Income Tax Act. These schemes enjoy triple tax benefits.

  • Investments in Equity Linked Savings Schemes are exempt from taxes under Section 80C of Income Tax Act 1961. By investing up to Rs 150,000 (maximum allowable investment under Section 80C), investors can save up to Rs 46,350 in taxes.

  • There is no taxation during the investment tenure in Equity Linked Savings Schemes, unlike say bank fixed deposit, where the investor has to pay tax on the interest earned. Dividends paid by Equity Linked Savings Schemes are also tax free.

  • The redemption amount of Equity Linked Savings scheme is also entirely tax free. Equity Linked Savings Schemes have a lock-in period of 3 years. Since investors have to remain invested for three years, there is no incidence of short term capital gains tax. Long term capital gains in Equity Linked Savings Schemes are tax free.

As such, in taxation parlance, Equity Linked Savings Schemes are exempt – exempt – exempt investments. They are exempt from taxes at the time investment, during the tenure of investment and also at the time of redemption.

Liquidity

Equity Linked Savings Schemes (also known as Tax Saver Funds) offer more liquidity compared to most tax saving (Section 80C) investment options. Equity Linked Savings Schemes have a lock-in period of 3 years. If you are investing in ELSS through systematic investment plan (SIP), each SIP instalment will be locked- in for three years. Most Section 80C investment options, other than ELSS, have a minimum lock-in period of 5 years.The dividend option of Equity Linked Savings Schemes(ELSS) provides investors with the option of getting tax free income from their ELSS investment during the lock-in period and beyond. Investors should however note that mutual fund dividends are paid at the discretion of the scheme’s fund manager. There is no assurance with regards to timing or amount of dividends paid by mutual funds.

Equity as an Asset Class

Equity Linked Savings Schemes invest in diversified portfolio of stocks across different sectors and market capitalization segments. Though ELSS investments are subject to equity market risks, equities have been the best performing (in terms of returns) asset class in the long term. Rs 1 lakh invested in the Sensex 20 years back would have grown to Rs 7.8 lakhs, while the same amount invested in gold and fixed deposit would have grown to Rs 5.2 lakhs and Rs 4.4 lakhs respectively.

Systematic Investing

Mutual fund offers investors the benefit and convenience of disciplined investing through Systematic Investment Plan (SIP). By providing an ECS mandate, a fixed amount on a fixed date gets debited automatically from your bank account every month (or any other frequency) and gets invested in the mutual fund scheme of your choice. Through an SIP in ELSS or Tax Saver Funds, you will not only be able to meet your tax saving needs for the financial year, but also, over a sufficiently long period of time, create wealth through disciplined investing. SIPs take advantage of the volatility in stock markets, through rupee cost averaging generating superior returns for investors in the long term.

The chart below shows the wealth created by a hypothetical Rs 5,000 SIP in ELSS over a period of 20 years assuming 15% annualized returns.


Wealth created by a hypothetical Rs 5,000 SIP in ELSS over a period of 20 years


You can see that, with a monthly SIP of just Rs 5,000 you can accumulate a corpus of around Rs 14 lakhs in 10 years and a corpus of Rs 75 lakhs in 20 years, assuming a return of 15%. The maximum benefits of the equity investing are seen over a long investment horizon (the longer the better). Therefore, in our view, even though Equity Linked Savings Schemes have a lock-in period of just 3 years, investors should plan on remaining invested much longer. ELSS investments are suitable for tax saving and long term investment objectives like children’s higher education, children’s wedding, retirement planning or simply wealth creation.

Best tax saving mutual funds: some examples

Principal Tax Saving Fund:

This is one of the best performing ELSS funds as per CRISIL’s mutual fund ranking report. This fund was ranked Number 1 by CRISIL for the March 2017 quarter. The fund is a hidden gem with only about Rs 290 Crores of Assets under Management (AUM). One the performance side the fund has been outstanding. In the last 12 months, Principal Tax Saving Fund has given more than 35% returns beating the category average by a wide margin. The fund gave 18% and 25% annualized returns in the last 3 and 5 years respectively, outperforming the category average. Principal Tax Saving Fund was launched in 1996. The expense ratio of the fund is 2.81%. The scheme investment style is growth oriented and the scheme portfolio has a large cap bias.

DSP BlackRock Tax Saver Fund:

This is a popular tax saver fund grabbing ratings and investor eyeballs over the past year or so. CRISIL has assigned number 1 ranking to this for the quarter ended March 2017. DSP BlackRock Tax Saver Fund was launched in 2007 and has Rs 2,630 Crores of Assets under Management. The expense ratio of the fund is 2.5%. The scheme’s investment style is growth oriented and the scheme portfolio has a large cap bias. In the last 12 months, DSP BlackRock Tax Saver Fund has given more than 29% returns beating the category average. The fund gave 20% and 23% annualized returns in the last 3 and 5 years respectively, higher than the category average.

L&T Tax Advantage Fund

CRISIL has ranked L&T Tax Advantage Fund 2nd in the quarter ended March 2017. This former Fidelity tax saver fund acquired by L&T Mutual Fund was launched in 2006 and has Rs 1,880 Crores of Assets under Management. The expense ratio of the fund is 2.43%. The scheme’s investment style is growth oriented and the scheme portfolio has a large cap bias. In the last 12 months, L&T Tax Advantage Fund has given more than 32% returns beating the category average. The fund gave 19% and 21% annualized returns in the last 3 and 5 years respectively.

Conclusion

In this post, we have discussed why Equity Linked Savings Schemes are the best tax saving investment options for wealth creation. They score higher than many 80C tax saving options on multiple fronts like returns, liquidity, flexibility, tax efficiency and method of investing (like SIP) etc. You can invest in ELSS or tax saver funds both in lump sum and SIP. SIP offers investors the convenience of disciplined investment from regular savings with huge long term wealth creation potential. We also discussed about some top ELSS funds. Investors should discuss with their financial advisors if ELSS funds are suitable for the tax planning needs.

Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.

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Dwaipayan Bose

An alumnus of IIM Ahmedabad, Dwaipayan is a Finance and Consulting professional, with 13 years of management experience, mostly in MNCs like American Express and Ameriprise Financial, both in India and the US. In his last role, he was the Chief Financial Officer of American Express Global Business Services in India. His key interests are building best in class organizations, corporate governance and talent development

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