It would be better to link them to long-term goals such as retirement
Tax-Saving ELSS funds are fairly popular. Along with the obvious benefit of tax saving, they also provide potentially higher returns because of their investments predominantly being in equity.
But I regularly see people investing in ELSS funds randomly and just to save taxes and get some good returns. Nothing wrong in this approach. After all, what can be wrong about saving taxes and earning good returns?
Unfortunately (and unknown to most), this approach doesn’t take them anywhere.
It’s true that Section 80C savings provide tax benefits. But 80C investments shouldn’t be made just for savings taxes. Rather, they should be linked to financial goals. It would be better to link them to long-term goals such as retirement.
Saving for goals
Because these ELSS funds are nothing but equity funds. And when it comes to equity, it is advisable to hold it for the long term (generally 5-7 years or more), to get the maximum potential benefit of high returns and not just till the end of lock-in after three years. The wealth creation potential of ELSS funds is best-suited to meet the savings requirements for long-term financial goals such as retirement planning, children’s education and marriage.
So tag ELSS investments to a long-term goal. In equity, poor short-term returns are a distinct possibility due to the risk-reward structure of the asset class. So, if one is willing to wait for long, then it helps in overcoming any effects of short-term market volatility.
Here is an example of how to link tax saving investments with retirement.
- Let’s say you decide to have a moderately aggressive allocation for retirement savings. Something like 60:40 in Equity:Debt.
- Now, you do your calculations and find out how much you need to invest every month for the target retirement corpus using the above-chosen allocation. Let’s say this comes to Rs 24,000 per month
- So based on 75:25 allocation, you need to invest Rs 18,000 in equity and Rs 6000 in debt every month.
- But being salaried, your employer is already deducting Rs 3000 every month in EPF contribution. This too counts towards the 25 per cent debt allocation. So, EPF takes care of Rs 36,000 per year under Section 80C tax saving.
- The remaining required amount for debt investment is Rs 3000 per month (Rs 6000-Rs 3000 in EPF contributions). This Rs 3000 can be invested via VPF or PPF.
So, till now, you have invested Rs 72,000 annually in eligible deductions (using EPF and VPF/PPF). Now, you require another Rs 78,000 annually for fully utilizing the Section 80C limit of Rs 1.5 lakh. In addition, you also need Rs 18,000 per month towards equity.
- You can now do a Rs 6500 SIP in ELSS fund; i.e., Rs 78,000 annually and this will take care of tax-savings via Section 80C.
- For the remaining Rs 11,500 (in the equity bucket of Rs 18,000), you can choose other normal non-ELSS equity funds.
Note: The above scenario doesn’t include deductibles from insurance premiums, home loan principal repayments, etc.
Avoid investing randomly
As you have seen above, how much you invest in ELSS isn’t a random choice. It is rather chosen as a part of an overall investment plan for the goal of retirement.
And if by chance, the Section 80C limit of Rs 1.5 lakh is already exhausted with EPF contributions, insurance premiums, etc., there is no need to put additional money in ELSS funds. You can simply choose regular non-tax-saving equity funds.
I would also caution you against being influenced by the PPF vs ELSS comparisons that start floating around near the end of financial year. It’s not right to compare ELSS with PPF.
ELSS is good for long-term investments as it allows you to earn inflation-beating long-term returns. And atleast on the average return front, it scores better than most other tax saving products.
So, for most common people, it is good to stick to goal-based financial planning and make tax-saving a part of retirement portfolio investments.(The writer is the founder of StableInvestor.com)