What is an ELSS Fund?
As the date for filing income tax returns comes nearer, you will have plenty of things on your mind. Like finding the bill for that travel expense you have claimed, finding out what that unexplained entry in your bank statement is, or if you have invested enough in tax-saving schemes to reduce your tax liability. But whatever our worries, the one thing you should not forget is to invest in an equity-linked savings scheme or ELSS. If you want to benefit from investing in the stock market and save tax at the same time, ELSS is your magic mantra. Of course, you must also remember that investments in mutual funds involve market risks and you should read the offer documents carefully before investing.
ELSS funds meaning
So what is an ELSS fund? ELSS is a kind of equity fund that gives you a tax deduction benefit of Rs 1.5 lakh under Section 80 C of the Income Tax Act. What this means is that you will be able to shave off Rs 1.5 lakh from your taxable income, a considerable saving especially if you are in the higher tax bracket. Of course, there’s a bit of a catch. There’s a lock-in period of three years for ELSS funds, and you will have to hold them for that time period if you to benefit from the tax deduction.
The lock-in period is also applicable to a systematic investment plan (SIP). So if you are putting in Rs 2,000 in a particular month, you will have to hold that investment for three years from that date.
Calculating the benefit of ELSS
Let’s see how much tax you will be saving from ELSS. Suppose you have an income of Rs 10 lakh, you will have to pay income tax of Rs 1.12 lakh. If you invest in ELSS of Rs 1.5 lakh, your taxable income will go down to Rs 8.5 lakh so you will have to pay only Rs 82,500. So your tax savings will be Rs 29,500.
ELSS funds have shown a compounded annual growth rate (CAGR) of 17.5% in the past. So if you invest Rs 1.5 lakh in ELSS, your investment would have gone up to Rs 243, 335. So your gain would be Rs 93,335.
So overall, by investing Rs 1.50 lakh, you would have saved tax of Rs 29,500 and earned returns of Rs 93,335. So your net gain from investing in ELSS would be Rs 1.23 lakh. Not bad at all.
Of course, you have to remember that there’s no way of guaranteeing returns in the equity market. So all your calculations could go awry if the markets don’t behave as per expectations.
Other alternatives under Section 80C
Now that you know what is ELSS, let’s take a look at the other alternatives that enjoy the benefit of Section 80C:
-
Public Provident Fund (PPF): PPF is a very popular investment option, especially for conservative investors. It is fully guaranteed by the central government, so it’s a perfectly safe investment. Any resident Indian can open a PPF account. Investing in this scheme has a double tax benefit – both the principal and the accrued interest are exempt from income tax. But there are a couple of drawbacks to this scheme. One is that the interest rate, which is fixed every quarter, is quite low at 8% (in November 2018). Another drawback is that you have to invest for a period of 15 years.
-
National Savings Certificate (NSC): NSC is a government scheme intended for small investors. NSC can be purchased from any post office in India and have a maturity period of five years. Here again, interest rates are on the lower side at around 8 percent.
-
Five-year bank deposits: You can invest in specified bank deposits for five years and get the benefit of Section 80C. Each bank fixes its own interest rates — currently, they vary from 7 percent to 8.25 percent (as of late 2018).
All these investments are low-risk but also earn much lower returns than ELSS.
Dividend and growth options
ELSS funds have dividend and growth options. You can get the benefit of any dividend declared by the mutual fund company, even during the lock-in period. If you opt for the growth option on the other hand, the dividend will be reinvested in the fund. It’s generally a better idea to opt for the growth option, since you get a bigger sum at the end of the lock-in period. ELSS funds must not be seen as just a tax-saving thing, but a good investment option in its own right.
Pros and cons of investing in ELSS funds
Pros
-
High returns: ELSS funds offer much higher returns than any other instrument available to taxpayers under Section 80C.
-
Lower lock-in period: Lock-in period is three years for ELSS funds, compared to 15 years for PPF, and five years for NSC and tax-saving bank deposits. However, the lock-in period could be a plus since you stay invested in a longer period and earn higher returns.
-
Diversification: You can diversify into the equity market by investing in an ELSS fund and maximize returns. ELSS funds are also diversified and invest in a variety of stocks, so the risks are spread out. What other investment avenue offers the opportunity to invest in equity and save tax at the same time?
-
Easy to invest: It’s easy to invest in ELSS funds, especially if you are already an investor in mutual funds. If you want to invest through your mobile phone, download the Angel BEE mutual funds app on your phone and invest instantly.
-
Systematic Investment Plan (SIP): Another advantage of an ELSS fund is that you can make small investments each month through a SIP according to convenience and saving ability.
Cons
-
Higher risk: An ELSS fund, like other equity funds, carry market risk. There’s no way to predict the movements of share prices in the future. But whatever the ups and downs of the stock market, the longer-term trend has always been upward. Other tax-saving instruments like PPF and NSC carry little risk because they are guaranteed by the government.
-
Lower liquidity: ELSS funds have a lock-in period of three years, so to that extent, they are less liquid.
How to invest in ELSS funds
If you are a first-time investor, the document can be quite cumbersome in the beginning.
First, you need to get the Know your Investor (KYC) formalities done. This is required for the most investments, including mutual funds and stocks and even to open a bank account. A visit to the office of the mutual fund company or a distributor should help you sort matters out.
After that, you can choose from the variety of ELSS funds available on the market. Make your pick by comparing returns from various schemes. You can download the Angel BEE mutual funds app, which ranks various funds according to their performance.
You can buy the mutual fund directly from the company or from a distributor. A distributor may be in a position to offer more choices than a mutual fund company, which will have only its own offerings. Doing it online is a very good option since you can do it from the convenience of your home, and at any time. Use the Angel BEE mutual funds app to invest in using your mobile phone. It will only take a minute or two.
You can either invest in a lump sum or take the SIP route. Both are eligible for tax deduction under Section 80C.
