The introduction of the Equity Linked Savings Scheme (ELSS) has provided much-needed relief for middle-class people, particularly the working class.
At a time when inflation has been rising, investing in traditional instruments with nominal returns of 8-10% has become too mainstream and unaffordable.
For novice readers, if returns in a tax saver fixed deposit is around 9%, and inflation is 5%, you are effectively making only 4% wealth on the invested amount.
This kind of lower single-digit return is not justified, particularly when your economy is in the growth phase and has a long run to go.
In this blog, we shall discuss why ELSS is considered the best investment instrument for tax saving purposes and what are the associated benefits with the same.
One of the most important benefits of ELSS is that the lock-in period for such funds is as low as three years. When compared with the traditional instruments ELSS has a short lock-in period.
The Lock-in period is the period for which the investment will be blocked with no flexibility of pre-maturity or withdrawal (including partial withdrawal).
Let us look at the traditional instruments and their lock-in periods:
1. Public Provident Fund (PPF) comes with a lock-in period of 15 years
2. Tax saver fixed deposits come with a lock-in period of 5 years
3. National Savings Certificate or the Kisan Vikas Patrika typically comes with 6-8 years of lock-in period
Thus, we see that ELSS has the lowest lock-in and your funds are made available to you in just a few years.
Does this mean you can only invest for three years? This brings us to discuss the second benefit provided by ELSS.
The flexibility provided by mutual funds is unmatched.
In ELSS, there is nothing called maturity and you can remain invested for as long as you wish. Three years is the minimum period you need to remain invested, post that the onus of investment duration lies on you.
We believe an investor is best rewarded when he/she remains invested for a long-term, that is 7-10 years or even more such as 15-20 years.
Choosing such a long-term investment provides the investor with the compounding benefit that helps him/her accumulate sizeable wealth.
Also, a business typically goes through a cycle on a long-term horizon and thus, as an investor you tend to get the maximum benefit if you remain invested for the entire duration.
Let us make this argument clear with the help of an example:
Below is the chart and a table depicting the wealth accumulated by investing in Aditya Birla Tax Relief 96 plan. We have also presented the scenario for three years and five years below.
As seen above, an investor who remained invested for a long-term accumulated 25 times more wealth than the one who invested for only ten years.
Unlike traditional investment instruments, ELSS is also a market-linked equity scheme.
This structure enables an ELSS scheme to provide an edge over the fixed return investments that offer tax benefits. As highlighted in the introduction section, the primary issue with the fixed return scheme is that with rising inflation the effective returns tend to reduce.
You may also want to read, Advantages and Disadvantages of ELSS
On the other hand, with market-linked returns, the alpha over the inflation rate tends to remain high as during different market phases the performance tends to vary.
This helps in negating the impact of inflation over the long term.
ELSS provides multiple ways of investment.
Systematic Investment Plan (SIP) and the Lumpsum plan are the two ways by which an investor can invest. SIP allows you to invest regularly on a fixed date that is pre-determined.
This approach helps in inculcating a habit of saving among investors. Also, given the cost of purchase (read as Net Asset Value or the NAV) differs depending on the market performance and changes daily; a SIP way prevents an investor from timing the market.
This method of investment typically provides investors with multiple price points for investing, thus helping with rupee cost averaging.
Any mutual fund including ELSS is managed by Asset management companies (AMC) or mutual fund houses.
The Securities and Exchange Board of India (SEBI) regulates these companies. The regulator has mandated the AMC to make periodic disclosures covering key information about mutual funds managed by them.
The key information disclosed are net asset value (NAV), assets under management (AUM), returns over the different periods, fund manager, total expense ratio, and current allocation to different sectors and stocks.
While some of the information is reported daily, others need to be published as per a monthly or quarterly schedule.
Besides, the regulator has provided a unique ARN code for every distributor involved in the selling of funds and a unique investment advisor number to individuals and companies that offer such service.
These codes can be used by an investor to file a complaint should there be an event of malpractice or misrepresentation or mis-spelling of schemes.
To sum up, we believe investing in a tax planning scheme remains the top priority for investors. For those who are yet to finalize any investment, however, the time is near when your HR manager will knock at your door for the proof.
Check out some of the Groww recommended ELSS schemes to invest in and take the benefit of the young and growing economy we live in. Also, there are many more benefits to mutual funds to save tax.
We shall cover some in our next update, until then
Happy investing and ELSS kar le!
Disclaimer: The views expressed in this post are that of the author and not those of Groww