Why are ELSS funds getting popular?

ELSS funds give individuals a tax rebate on the investment (up to a cap of Rs1.50 lakh per financial year) under Section 80C of the Income Tax Act, and secondly, since ELSS is an equity fund, it aids in wealth creation over the longer term

Dec 30, 2018 04:12 IST India Infoline News Service

Equity Funds
Equity-linked savings schemes (ELSS) are akin to hitting two birds with one stone. Firstly, they give individuals a tax rebate on the investment (up to a cap of Rs1.50 lakh per financial year) under Section 80C of the Income Tax Act, and secondly, since ELSS is an equity fund, it aids in wealth creation over the longer term. The mandatory lock-in period of 3 years also instills the discipline of long-term investing. As such, ELSS give the dual benefit of wealth creation and tax saving.

How the tax benefits add punch to ELSS

Let us consider Dipti’s example; she invests Rs1.5 lakh in an ELSS fund to save tax. Let us also assume that she is in the 30% tax bracket (we have ignored cess and surcharge).

Particulars Amount Particulars Amount
Total Investment Rs1,50,000 Section 80C (30%) Rs45,000
Start NAV of ELSS Fund Rs20.00 Effective Investment Rs1,05,000
CAGR Return (%) 14% End Value Rs2,22,232
End NAV of ELSS Fund Rs29.63 Effective CAGR (%) 28.40%
Tenure of holding 3 years Yield Advantage +14.40%

The above illustration captures how the tax shield has enhanced her annual CAGR returns by 14.40%. When she gets the 30% tax rebate in the year of investment, her effective investment comes down by that amount. This adds the punch to her effective returns. Of course, you can argue that the capital gains at the end of 3 years will be taxed at 10%. In the above case, since the LTCG will be less than Rs1 lakh, LTCG tax will not be applicable. This is what makes ELSS so attractive to first-time investors like Dipti. She saves tax and also creates smart wealth in the process.

Why have ELSS funds become so popular in India?

·         ELSS funds do not require much effort from the investor in terms of monitoring. It is an auto wealth creator and the investor stays passive in the process.
·         ELSS funds can be structured in the form of SIPs. You just allocate a fixed sum to an ELSS each month and consequently make your tax planning a more disciplined process.
·         For first-time investors, ELSS is a great gateway to equity participation. If you are uncertain about equities and confused about equity funds, then ELSS can be the answer.
·         ELSS funds instill discipline in the fund manager due to the mandatory lock-in period of 3 years. Fund managers are required to hold less cash due to the sticky nature of flows.
·         Among the other tax-saving instruments like PPF, ULIP, long-term deposits, etc., ELSS has the lowest lock-in of 3 years. Once the lock-in is over, the ELSS investment is quite liquid.
·         There are no restrictions on the quantum of investment. If you find an ELSS performing well, you can even invest beyond the Rs1.5 lakh limit, unlike PPFs.
·         The investment process is quite simple and only a basic one-time KYC is required. If you register an SIP, the contribution process gets into auto mode.

Are there any precautions required when investing in ELSS?

There are three points that one should keep in mind when investing in ELSS mutual funds.

·         Section 80C is a blanket exemption of Rs1.50 lakh which includes other contributions like CPF, PPF, insurance premium, long-term deposits, tuition fees. etc. Only invest in ELSS to the extent of the gap. After that, stick to equity funds, where there is no lock-in.
·         Fund selection is critical since there is a wide range of choice. Ideally, consult your advisor but also do your own research in the form of checking the particular fund’s historical performance, risk metrics, volatility, etc., before investing.
·         ELSS has a mandatory lock-in period of 3 years and it cannot be liquidated before this. Any such forced liquidation will result in the loss of the tax shield and such exemption will be added back to your taxable income.

ELSS surely remains one of the best ways of combining wealth creation and tax-saving and is certainly a smart way to start your equity journey.

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