Why You Should Opt for Mutual Funds to Save Tax

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 are 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, mainly 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 the associated benefits of the same.

Reasons to Opt for Mutual Funds to Save Tax

Following are some of the prominent reasons to opt for mutual funds to save tax-

1. Lock-in Gets Reduced

One of the most essential benefits of ELSS is that the lock-in period for such funds is as low as three years. When compared with traditional instruments, ELSS has a short lock-in period.

The Lock-in period is when 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-

• Public Provident Fund (PPF) comes with a lock-in period of 15 years
• Tax-saver fixed deposits come with a lock-in period of 5 years
• National Savings Certificate or the Kisan Vikas Patrika typically comes with a 6-8 years 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.

2. Flexible Investment Tenure

The flexibility provided by mutual funds is unmatched.

In ELSS, there is nothing called maturity, you can remain invested for as long as you wish. However, three years is the minimum period you need to stay invested, post that, the onus of investment duration lies on you.

We believe an investor is best rewarded when they remain invested for a long term, 7-10 years or even more, such as 15-20 years.

Choosing such a long-term investment gives the investor the compounding benefit that helps them accumulate sizeable wealth.

Also, a business typically goes through a long-term cycle; thus, as an investor, you tend to get the maximum benefit if you remain invested for the entire duration.

3. Higher Market Linked Returns

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 limited return scheme is that adequate returns tend to reduce with rising inflation.

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.

4. Flexibility with Investment

ELSS provides multiple ways of investment.

Systematic Investment Plan (SIP) and the Lumpsum plan are the two ways investors 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 investment method typically provides investors with multiple price points for investing, thus helping with rupee cost averaging.

5. High Degree of Compliance and Transparency

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 essential information about mutual funds managed by them.

The critical information disclosed are net asset value (NAV), assets under management (AUM), returns over different periods, fund manager, total expense ratio, and current allocation to other sectors and stocks.

While some of the information is reported daily, others must be published 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 a service.

An investor can use these codes 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.

Disclaimer: This blog is solely for educational purposes. The securities/investments quoted here are not recommendatory.