Monday, November 02, 2009

(November 2009)

ELSS on the march…

According to a study, if you remained invested in Sensex shares for any block of three years during the past 27 years, your average annual return would have been 26.95%. The potential of ELSS Funds to create long-term wealth has not escaped taxpayers’ notice. Ever since Section 80C removed the sub-limit of Rs 10,000 per year on tax saving funds four years ago, the category has grown exponentially. From 18 funds managing about Rs 900 crore in January 2005, it has grown to nearly 30 tax saving funds managing over Rs 15,000 crore today. The only other tax saving option, which has grown at such a scorching pace is insurance. There, too, growth has largely come from unit-linked insurance plans (ULIPs), which is more of a mutual fund than an insurance plan.

Brief grief

During the past year (October 2008 – October 2009), ELSS funds were in doldrums in the first half of the year in line with the dismal performance of the stock market, but bounced back in the latter half. ELSS Funds collected Rs 3,808 crore between January and March 2008. During the fourth quarter of 2008-09, they managed to mop up Rs 1,134 crore – representing a fall of 70.20%. In March 2009, fund houses collected Rs 547 crore, which was 73% lower than the Rs 2,071 crore raised in March 2008. The ELSS Funds have more than made up for the lacklustre performance by displaying a scintillating show in the second half of the year under consideration.

Attractive investment proposition

When you invest in ELSS, your money is locked for a period of three years (minimum). This acts as a blessing in disguise as tax saving funds generally yield high returns during a 3-year period. The common man is basically afraid of investing his money in equity shares as he is afraid of loosing money. But a look at the recent past shows that investors who have invested in ELSS funds have never lost out on their money. In fact, they have been the front runners in terms of returns to investors. A small illustration will clarify this. If you make an investment of Rs 1,00,000, then under section 80C this complete amount is deducted from your gross income for that particular year. If your annual income puts you in the highest tax paying zone, i.e 34%, then the investment of Rs 1,00,000 will ensure that you get an annual tax deduction of Rs, 34,000. So, logically speaking, you invest Rs 66,000 considering the deduction. Assuming that the mutual fund declares an annual dividend of 10% then your total return on Rs 66,000 is [(10,000/66000)* 100] = 15.15%. This particular dividend earned is also tax-free, thereby, enhancing profitability. Another profitable proposition out of this investment is that after a period of 3 years, the capital gain that you obtain out of the investment is also tax-free. This is what makes ELSS the most attractive investment for those who have the appetite for moderate risk. ELSS is considered to be the best tax saving mutual fund scheme in India.

One up on other savings schemes

If we travel backwards in time by five years, ELSS Funds have delivered an annualised return of not less than 12% on an average. This is much higher than the returns you get on other instruments under 80C, which offer an average return of 8 to 9% p.a.

When it comes to the lock-in period, ELSS scores high since its lock-in is a mere three years as against a minimum of five years in the case of the other 80C instruments.

The tax benefits are attractive – dividends are tax-free and when you sell the units after three years, you need not pay tax since there is no long-term capital gains tax on equity funds.

On the tax front, it outsmarts Fixed Deposits and National Savings Certificate. ELSS investments can be withdrawn after three years and there is no tax on profits. If you reinvest in the ELSS fund, you get tax exemption twice in six years compared to just once in case of NSCs and Fixed Deposits.

In terms of lock-in, returns, and regular income, it is one up on Public Provident Fund too. “Dividend Delight” is the correct synonym for ELSS Funds. They are known for showering dividends on investors. Considering the fact that investment amount is locked-in for three years, all ELSS Funds practise giving handsome dividends. ELSS investment is a great income generation tool.

The golden mean

However, ELSS funds invest in stocks and carry the same risk as any equity fund. The best way to invest in them is through monthly instalments called SIPs. They even out the ups and downs by averaging your cost of purchase over the long term. You can barely squeeze in two instalments before March 31. For instance, if you are planning to invest Rs 20,000 in ELSS funds for Section 80C benefits, invest Rs 10,000 right away and another Rs 10,000 a month later, just before the end of the financial year. For the period - January 1, 2008 to January 1, 2009 - possibly the worst phase of the current crisis, a systematic investment in an ELSS fund would have limited your losses to 34% as against the loss of nearly 50% suffered by the Sensex.

…blocked by an unexpected turn?

It is surprising that ELSS, the only all equity tax saving option open to investors, does not figure in the new tax code that will be taken up for discussion. What still defies understanding is whether that is by omission or design. It is highly sceptical that it is by omission since there are four aspects in all, out of which two are conspicuous by their absence. ELSS may cease to exist in its current form because if there is no 80C, there cannot be an 80C Fund (read ELSS Fund). The new tax code is not an amendment or revision, it is a replacement. It substitutes the existing tax system in the land. Apparently, it looks as if equity-linked savings scheme will not exist in its current form after the tax code comes into play.

ELSS is a very good instrument – cost-effective, well-regulated, and transparent. Its inclusion in the portfolio enhances the quality of the portfolio. A very strong case can be built by the Indian mutual fund industry in order to have it in a different form. The new Direct Taxes Code Bill might give rise to new tax-saving funds that are very long-term funds. Redemption might get linked to the retirement of an individual or his retirement age. A new product could evolve….the mutual fund industry will have to work harder and make its voice heard…

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