Here is why ELSS outscores other options available under Section 80C and few things to keep in mind while investing in ELSS mutual funds.
Highest returns: ELSS are tax saving mutual funds, which primarily invest in equities and equity-related instruments. Although equities can be very volatile in the short term, they easily beat all other asset classes (including fixed-income products like bank deposits) over the long term by a very wide margin. A long term investor in ELSS can easily expect over 12% annualised returns while almost none of the other Section 80C products presently deliver beyond 9% p.a. annualised returns. Although, equity-oriented ULIPs can theoretically deliver similar returns like ELSS, their higher fund management cost and other expenses do not allow them to outperform ELSS funds over the long term.
Shortest lock-in period: ELSS funds come with a lock-in period of just 3 years, the lowest among all Section 80C products. Among other popular Section 80C options, tax-saving fixed deposits have a lock-in period of 5 years, NSC have lock-in periods of 5 years while PPF has a lock-in period of 15 years. ULIPs, the nearest competitor of ELSS in terms of returns, have a lock-in period of 5 years. Your investments in National Pension Scheme will stay locked-in till your retirement.
Tax free dividend and maturity: In terms of taxation, ELSS comes under the EEE (exempt-exempt-exempt) category. It is not just their investment amount, even their dividend income and maturity proceeds are entirely tax free. PPF is the only other Section 80C product falling under EEE regime. While the interest earned on tax-saving bank and post office FDs and NSCs are taxed according to your tax slab, investment products like NPS and pension plans are taxed at the time of maturity. In the case of ULIPs, if the premium paid is more than 10% of the sum assured, the entire maturity proceeds is taxable according to your applicable tax slab.
Instils financial discipline: Just like other mutual fund schemes, ELSS allows you to invest regularly (monthly) through Systematic Investment Plan (SIP). The biggest advantage of SIP is that it allows you to invest small sum every month, thereby reducing the stress on your liquidity at the end of the financial year. This periodic and automatic investment schedule also forces you to save and invest regularly. By spreading your investment over the entire year, SIP also allows you to average your investment cost during market downturns.
Points to remember while investing in ELSS
Now, once you are the convinced of the superiority of ELSS over other tax-saving schemes, your next job is to select the most appropriate ELSS fund for yourself from over 40 available schemes.
Analyse your risk appetite
As each ELSS fund has its own style of investing, the market risk to their portfolio may vary from one fund to another. If your risk appetite is low to moderate, opt for a scheme that is primarily invested in large cap companies. The present market volatility (caused by both domestic and global factors) and steep valuation of mid cap companies makes a strong case of investing in large-cap oriented ELSS funds. Invest in ELSS funds with mid- and small cap bias if you have a high risk appetite and long investment horizon.
Compare their past performance
Before investing in a particular ELSS fund, make sure to compare its past performance (over the past 3 year and 5 year periods) with its benchmark index and other ELSS funds. Although the past performance of ELSS funds is no guarantee of their future performance, this comparison will at least show you how they have fared during the rising and falling markets and by what degree they have outperformed each other.
To sum it up, ELSS mutual funds outscore every other Section 80C options in terms of returns, liquidity and tax benefits. In fact, their high tax-free returns make them the most suitable vehicle for long term wealth creation. Invest in ELSS for achieving for achieving long term goals like creating corpuses for your children's education and for your post-retirement life.
By, Manish Kothari - Head of Mutual Funds, Paisabazaar.com