While selecting an investment instrument one has to evaluate it on various factors such as risk appetite, returns, liquidity, time horizon, tax benefits etc. Since we are at the beginning of the year and need to plan investment for tax purpose. There are different products available for saving tax ranging from National Saving Certificates (NSC), Public Provident Fund (PPF), National Pension Scheme (NPS) to ULIP of insurance Companies. All these products are suitable for different purposes and for different people. One of the product in this category is Equity Linked Saving Scheme popularly known as ELSS which has gained popularity in recent times due to various factors. In this article we shall review the various features of this products and discuss as to for whom this is suitable.
What is ELSS
ELSS is nothing but an equity oriented scheme of a mutual fund for which you are eligible to claim the tax benefits. The fund house invests the money in the equity shares of various companies. The scheme is approved by the Central Board of Direct Taxes for the purpose of granting tax benefit. Investment made in ELSS qualifies for deduction up to an amount of Rs. 1.50 lakh every year.
How it compares with other investment products?
This is the only investment product available with the smallest lock in period. The money invested in ELSS gets locked for three years and thus cannot be withdrawn before such lock in. Against lock in period of three years of ELSS some products like NSC, Tax Saving bank fixed deposits come with five year lock in period. Some other products like PPF, Provident Fund, NPS come with longer lock in tenure.
In addition to lower lock in period, ELSS has historically given better returns than other eligible products. The ELSS as a category has given an annual average return of 20.32% for three years and 17.59% for five years. In case you are able and lucky to select good scheme you may have earned better return. For example if you had selected Axis Long term Equity Fund three year and five average annual returns would have been 21.38% and 21.99% respectively.
How should one invest in ELSS
Since the money invested in ELSS ultimately gets invested in equity market and as the equity market are very volatile in short run, it does not make sense to invest whole of the money at one go, as the equity market may fall even 2-3% in one single day. So what should you do?
So like for making investments in National Saving Certificates of making a tax saving fixed deposits, you can invest the whole of the amount at one go but for making investments in ELSS you should invest over the year so that your investments is not adversely affected by short term volatility in the equity market. If you cannot enforce the discipline of making investing regularly every month, I would advise you to invest in the ELSS through monthly Systematic Investment Plan (SIP) so as to ensure that the money gets invested at regular interval without you having to do anything.
The best way to plan for making investments in ELSS is to do it now at the beginning of the year. First sum up all the tax eligible mandatory investment/expenses for the year, like provident fund deduction, life insurance premium, principal repayment of home loan, school fee for children. Deduct the same from the overall amount of deduction available of Rs. 1.50 lakh. Suppose the aggregate of such mandatory amount comes to Rs. 60,000 and you are left with Rs. 90,000 available for making investments in ELSS. Just divide this amount by 12 months if the exercise is being done at the beginning of the year or the number of months left in the financial year and the result is the amount for which you need to set up an SIP for the remaining months. In this example above you will need to set up an SIP of Rs. 7,500 every month. For the sake of diversifying the risk I would advise you to do two SIP of different good schemes of two different fund houses to avoid the risk of concentration in one scheme of one fund house.
For whom the ELSS is suitable?
As the doctors say that one medicine may not work for all the patients, the same applies to all investments products. ELSS though may have some of very good features but still may not be suitable for each and every person due to various reasons. Let us discuss for whom this is suitable and why.
Since the ELSS is nothing but investing in equity through the medium of mutual fund and therefore all the limitations of investing in equity equally apply here. Since the return on ELSS are not fixed and depend on the performance of equity market, the same is not suitable for a person who does not have enough ability to take risk. For taxpayers who do not have the risk appetite, the products like bank fixed deposits, National Saving Certificates (NSC), Public Provident Fund are better choice as the return on these instruments are generally fixed. This specifically applies to the persons who have retired and cannot risk their capital. Moreover though the lock in period is of only three years but the equity markets may not do well during the period and eventually you may have to continue to hold the investments till the market recovers and does well, so this may not be suitable if you have short fixed tenure of investment synched with fixed goal. So in case you have short fixed time horizon for investment, NSC and tax saving fixed deposits are better options for you. So ELSS is not suitable for you unless you have ability to take risk as well as flexible long time horizon for investment.
However for the persons who have started their career and have long time to stay invested as well as need money to pay for other future goals not of fixed tenure like margin money for buying house, education and marriage expenses for children can definitely take the benefit of this vehicle for investment.
This product is very good for the people who have liquidity problem but have flexible time horizon and already have existing investments in ELSS which has already completed the lock in period and do not want to liquidate due to unfavourable market condition. In such a situation what you need to do it to just recycle the existing ELSS investments by redeeming the existing units which have completed three years and buying the same at the same NAV on the same day. By doing this you will be able to claim the tax benefits for ELSS without actually having to invest any money. Since you do not want to actually redeem these units you will be just shifting your existing units while availing tax benefit. In order to recycle the existing ELSS units without taking any risk of market volatility you may have to temporarily arrange some funds till the redemption proceeds of your ELSS get credit to your bank account.
Moreover since the existing investment has become long term and does not have any tax liability this is effectively does not have any outgo implications except very small amount in the form of Securities Transaction Tax (STT) which the fund house will recover when you redeem existing ELSS investment.
Looking at the juncture at which the Indian economy is now, the equity markets are expected to give better returns in the longer run though may be volatile during intervening period, it makes sense for the people who have time on their side and also have the ability to take risk to invest in ELSS to avail tax benefits and to create wealth for themselves.Balwant Jain is a CA, CS and CFP. Presently working as Company Secretary of Bombay Oxygen Corporation Limited. He can be reached at email@example.com