FUND FLAVOUR

Equity Linked Savings Scheme

Versatility is the name of the game (scheme)!

100 per cent tax deduction, high returns, no lock-in period and full safety – looks like a Utopian dream. But the equity-linked savings scheme (ELSS) comes closer to achieving this Utopian dream. It offers 100 per cent tax deduction up to Rs 1,00,000 per year, it delivers returns higher than traditional investment avenues, it has a moderate lock-in period of three years and though equity and risk go hand in hand with each other, history has shown that most ELSS schemes have been safe and investors have rarely lost their money.

What is this versatile ELSS all about? ELSS was introduced to promote investments in equity markets by giving tax concessions to the investors. As the name lucidly suggests, it is a savings scheme that is linked to equity. It invests in stocks of various companies in different sectors. It is mostly open-ended in the sense that you can buy and sell units from the mutual fund anytime you desire (there are a few exceptions like TATA Tax Advantage – 1, which is close-ended).

So, is it just another diversified equity fund? In many ways, yes… but the difference lies in the tax benefit. These funds give a tax benefit of upto Rs. 1 lakh under Section 80C of the Income Tax Act. But, to get this benefit, your investment is locked-in with the fund for at least three years and the fund has to invest at least 80% of its corpus in equity.

Titans of tax saving

In case of a debt-oriented mutual fund scheme, short-term capital gains are taxed at the normal slab rates applicable to the individual. But long-term capital gains are taxed at the lower of 10% (without the benefit of indexation) or 20% (with the benefit of indexation). (Indexation is a factor used to adjust the impact of inflation to the cost of acquisition of mutual fund units).Equity-oriented scheme provides an added advantage, both in case of short as well as long-term capital gains. While the short-term gains are taxed at the moderate rate of 10%, irrespective of the income tax slab to which the individual belongs, long-term gains are exempt from tax. ELSS has an additional feather tugged to its cap! While the exit is tax free — since it carries a lock-in period of three years, rendering it as a long-term investment instrument — the initial investment is also eligible for deduction under the Rs 1-lakh threshold of Section 80C. ELSS schemes give twice the benefit as compared with diversified equity schemes. They give you tax sops on investments and are also exempt from long term capital gains tax.

Monarch in the money game

You are in the money game. At the end of the day, you want to know what you are getting in return for your investment. Over the years, the average return from tax-saving funds on the whole has far outweighed any fixed-income return. The average annual return over the past five years has varied from 16% to 108%. Compare this to the National Savings Certificate (NSC), which gives you an interest rate of 8%, and the Public Provident Fund (PPF) which gives you 8.5%. Besides having the potential to deliver the most lucrative returns, the lock-in period of three years is considerably less when compared with other tax-saving avenues like PPF (15 years) and NSC (6 years). Since tax-planning funds have a three-year lock-in period, it gives greater room to fund managers in making flexible investment decisions and taking massive sectoral bets. Consequently, majority of these funds are relatively more volatile than their equity diversified peers. But this should not be a cause for concern as over the long-term the returns get smoothened. Moreover, they are not required to hold huge cash, as they are usually not susceptible to a huge redemption. They provide decent scope for capital appreciation with added advantage of tax-free dividends. Though they do not provide an assured return, when reviewed over a long term horizon, they tend to give superior returns.

ELSS gives you the option of saving tax while participating in the growth of the capital market. ELSS are evergreen funds and are ideal for:

• Small investors as it is a simple way of investing in the stock market.
• Investors who may not have a lump sum to invest in order to save tax. Open-ended ELSS allows them to invest at various points depending on the availability of funds, as well as take advantage of cost averaging.

Constant tracking is passe. Daily statistics will tell you nothing. Consider investing in ELSS through a systematic investment plan so that you can fully exploit the potential of such funds. Tax planning should never be left till the end of the financial year - it should be an ongoing process. If you commit your money at one go, you will be at the mercy of the market. But by distributing it over the months, you minimise your risk. Develop an early tax planning strategy within the broad framework of your financial plan and take advantage of this versatile scheme.