ELSS vs Other Tax-saving Instruments

ELSS vs Other Tax-saving Instruments

By Akhil Chugh

Date September 26, 2021

Investing in mutual funds is a good way to grow your money in the long term. But while investing in mutual funds we are often confused about which fund to invest in. 

Now, your mutual fund investment should ideally be as per your investment horizon and the investment objective to create a sufficient corpus to reach your financial goal in a timely manner. But what if a category can give you more than just helping you to achieve your goal in a timely manner?

Enter ELSS funds – a wealth creation & tax-saving investment tool

In this blog, we will talk about what are ELSS funds, how are they better than other tax-saving instruments & top-performing ELSS funds.

What are ELSS Funds?

ELSS is a short-term or abbreviation for an Equity-linked savings scheme. ELSS (Equity Linked Savings Scheme) is an open-ended mutual fund in which the fund manager invests at least 65% of portfolio money in equity and instruments related to equity. 

These are the only mutual funds that can help you avail of a tax deduction under Section 80C up to a maximum investment of Rs 1.5 lakh in a financial year.

Some of the features of ELSS are:

  • Invests at least 65% of the portfolio in equity & equity related instruments
  • Lock-in period of 3 years
  • Invest in ELSS – SIP or Lumpsum
  • An investment made in ELSS can be claimed as a deduction under section 80C of the income tax act subject to a maximum overall limit of Rs. 1.5 lacs in a year of investment
  • Long-term capital gains from equity mutual funds above Rs 1 lakh is taxed at 10 percent

ELSS vs Other Tax-Saving Investment Alternatives

1. Shortest Lock-in Period:

If you compare the lock-in period for ELSS with other tax-saving investment options, then ELSS scores an extra point. 

The lock-in period for some of the popular tax-saving investment products is – PPF- 15 years, ULIP – 5 years, tax-saving FDs – 5 years, NSC – 5 years. But compared to that, the lock-in period for ELSS is only 3 years. 

Why ELSS is better tax saving investment
2. Higher Expected Returns:

Most of the tax-saving investments that are eligible for the tax benefits offer a return that is fixed. Equity Linked Savings Schemes (ELSS) provides returns that are variable which is linked with the investment portfolios and its performance. As a long-term investment equity market generates better returns and with ELSS, one is investing in equities & equity-related instruments, thus, investing for tax saving in ELSS holds the potential for higher and better returns. These returns are additionally boosted by the savings that are generated via tax benefits. 

Below is the table summarising the expected returns from different tax-saving instruments based on past performance:

Why ELSS is better tax saving investment 2

There are various instruments that can avail the benefits of Section 80C, like, Public Provident Funds (PPF), National Savings Certificates (NSC), Fixed Deposits (FD) and the latest, fast-growing Equity Linked Saving Schemes (ELSS). Among all these investments the ELSS has the shortest lock-in period of 3 years and, even though they carry higher risk, can reward the investor handsomely.

3. Inculcate Financial Discipline Through SIP:

Like all other mutual funds, it is easy to invest in ELSS through a SIP. You can start a SIP for an ELSS mutual fund at the start of the financial year. And like other mutual funds, as and when your income increases you can increase your investment amount through SIP top-up.

And if you want to get the full tax deduction for investing in these funds, you have the convenience of investing approximately Rs 12,500 every month instead of putting Rs 1.5 lakh in one go.

Most other tax-saving investment products do not provide a systematic way of investing money on a monthly basis.

4. Mutual funds taxation help you save more

ELSS funds have a minimum lock-in period of three years. And after three years, the long-term capital gains (LTCG) of up to Rs 1 lakh a year from ELSS mutual funds are exempt from income tax. However, the LTCG above Rs 1 lakh is taxed at 10%.

Now, in terms of the taxation policy, if you compare ELSS with PPF (which falls under Exempt and hence, the maturity amount is not taxed) you might feel that the benefit for investing in ELSS is less. However, a point that needs to be mentioned here is that PPF has a very long-term lock-in period, and such investments are not fit for fulfilling short-term or mid-term goals.

So, if you compare it with a 5-year FD, then investing in ELSS is much more beneficial in terms of their taxation policy. The returns from FDs are taxed as per one’s tax bracket. And if you fall under the 30% tax bracket, then your FD returns will be taxed at 30%.

Why ELSS is better tax saving investment
5. Protection from rising inflation:

ELSS funds also help earn returns that are able to beat inflation. While bonds and fixed deposits might offer returns that may be in line with the pace of inflation over a period of time, in reality, the real returns are quite low. Since ELSS funds are equity-based and returns are tax-efficient, they provide higher gains as compared to other investment options, which are in line with the increase in inflation.

Past SIP Performance of Top ELSS Funds

Based on the last 10-year SIP performance of ELSS funds, Net Brokers have collated a list of best tax-saving mutual funds to invest in 2021:

Top ELSS Funds to invest

Net Brokers Takeaways:

  • Net Brokers suggests its investors have a diversified portfolio, with investments made across the entire gamut of tax savings and profit-maximization schemes. One should definitely include ELSS funds in their investment portfolio because the risks they come with given that they are equity-based schemes are more than compensated for by their numerous advantages.
  • ELSS is one of the best tax-saving tools available to an investor to get the twin benefit of tax savings and an opportunity to harness the potential upside of investing in the equity market.
  • Taxation plays an integral role in overall financial planning; hence we strongly suggest investors plan their investments in ELSS systematically at the starting of the year and not towards the end of the fiscal. One can start looking at investing in an ELSS scheme through SIP to benefit from rupee cost averaging to beat market volatility and avail tax benefit up to Rs.1.5 lakhs for a year as per the current tax laws.
  • Equity markets can be volatile in the short term and therefore, investors should be patient and have a sufficiently long investment horizon for Equity Linked Savings Schemes (ELSS). Though the lock-in period for ELSS investments is 3 years, an investor should be willing to stay invested for a minimum horizon of 7-10 years to earn higher returns.
  • Before investing, make sure that to first understand how ELSS funds work and the risks involved to avoid any problems in the future. In case of any doubt, feel free to contact us here.

A detailed, goal-oriented approach is key to reaping the rewards of the money that you invest in ELSS. Remember to select the right ELSS funds that suit your long-term goals at the beginning of the year and invest regularly to see your wealth grow.

For more information, get in touch with us today! Download our mutual fund app & start investing in an ELSS fund to save tax and grow your capital significantly over the long term.

Happy investing!