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Save Tax with ELSS Mutual Funds November 25, 2011
In this article, we have explained the benefits and factors to consider while investing in Equity Linked Saving Schemes.
Author : Raju Singh


 Save Tax with ELSS Mutual Funds

The purpose of tax exemption under section 80C is to promote the habit of savings and long term investment. Unfortunately, however, we generally don’t plan for the ideal investment avenue in advance and take last minute decisions, disregarding all the good advice we know about choosing investment products well. With this article, we evaluate the ELSS mutual funds category, a Section 80C favourite, and discuss the best way to get the most out of your ELSS investments.

As per Section 80C of Income Tax Act, individuals are allowed to invest up to Rs. 100,000 in tax saving instruments, which will be deductible from their Gross Total Income. Tax-saving mutual funds (or ELSS i.e. Equity Linked Saving Schemes as they are more popularly known), Insurance Plans, PPF, and NSCs are some of the avenues where an investor can invest and save tax. When selecting a tax saving product, choose one that can help you meet your financial objectives and matches your saving patterns. Broadly, consider the following points:

  • Liquidity

Investment avenues available under section 80C carry lock in period ranging from 3 years to 15 years. So select a product which is in line with your investment horizon.

  • Risk & Returns

There is always a tradeoff between risk and returns - the higher the potential returns, the higher the risk. Select a product which is suitable to your risk appetite.

  • Inflation Protection

Inflation eats into the value of your returns. Consider “real returns” (Returns – Inflation) when evaluating whether a particular product can help you meet your financial objectives.

  • Tax implication at redemption

Apart from the tax benefit under section 80C, tax implications on the returns is also an important to point consider while selecting a investment product. The interest earned on Fixed Deposits or NSC (National Saving Certificate) is taxable and hence that reduces returns on these products. Long term returns on mutual funds (more than 1 year) are tax free.


Investing in an ELSS Fund

Equity Linked Saving Schemes are equity-oriented mutual funds with tax benefits. They score over other tax saving investment products in some respects. They have the lowest lock in period, i.e., 3 years, and being market linked have the potential to generate good returns over long term. Investors with moderate to high risk appetite should seriously consider investing in these funds. However, it is difficult to ignore the assured returns and capital protection aspect of other products like PPF, NSC and FDs.

Dividends received from ELSS funds are also exempt from tax. However, when investing in ELSS funds, it is advisable to not go in for the Dividend Re-investment option, as each re-investment will be treated as a fresh investment and will lock in your re-invested money for another 3 years. This loop makes it difficult to exit the fund completely at one point of time. It is therefore wise to select either the Growth or Dividend Payout option in these funds.

The same logic applies if you decide to go in for an SIP mode of investing in ELSS funds. While SIPs are very desirable in terms of allowing disciplined and small investments, each SIP installment is locked in for three years from investment, creating a similar loop.

Lastly, this might be the last year that allows you to take advantage of the tax savings offered by ELSS funds. If the parliament passes the Direct Tax Code in its winter session, ELSS funds along with many other investment products may no longer attract tax exemption after April 2012.  Any fresh investment in an ELSS fund after April 2012 will be treated as an equity mutual fund investment.

Selecting an ELSS Fund

All together 48 Equity Linked Saving Schemes are available in the market. Of these, 37 funds are open-ended funds, of which 30 funds have a track record of 3-years or more. Only 14 funds out of 30 manage to beat the category average in the 3-year period. So selecting a right fund is more important, as the money is going to be locked in for 3 years.

For selecting an ELSS fund, one can evaluate the following parameters:

  • Historical track record of the fund: The historical performance of the fund can be evaluated across various time periods to see how the fund has performed compared to its benchmark or other comparable indices and the peers. That apart, fund performance in falling markets can also be looked at to get better perspective about the fund.
  • Consistency of the Fund: Consistent performance is an important point to consider when selecting a fund. Some funds give phenomenal performance in one time period and are not able to continue that in future. So prefer to choose a fund that has a history of consistent performance.
  • Track record of the Fund Manager: The Fund Manager is the main driver behind the investment strategies of the fund. Historical performance of the Fund Manager can be reviewed by evaluating the performance of the funds managed by him.

Performance of Top 10 ELSS based on 3 year returns

 
CAGR %
Scheme Name
3 Years
5 Years
7 Years
10 Years
Canara Robeco Equity Tax Saver Fund (D)
32.49
14.10
22.09
21.89
ICICI Prudential Tax Plan (G)
31.83
6.21
19.30
28.35
HDFC TaxSaver Fund (G)
28.91
7.86
21.81
29.10
Fidelity Tax Advantage Fund (G)
28.56
11.30
NA
NA
Religare Tax Plan (G)
28.19
NA
NA
NA
Franklin India Taxshield Fund (G)
27.54
10.20
19.41
25.69
ING Tax Savings Fund (G)
26.63
1.55
14.53
NA
HDFC Long Term Advantage Fund (G)
26.46
6.70
16.91
29.40
Sahara Tax Gain Fund (G)
25.92
11.13
8.19
15.29
Taurus Tax Shield Fund (G)
25.46
13.06
14.33
16.87
                                                                                                                Returns as on Nov 15, 2011     Source: Ace MF, iFAST compilations

Equity Linked Saving Schemes have a good track record, with performance similar to diversified funds. The category average returns on 3-yr, 5-yr, 7-yr and 10-yr are 22.23%, 5.20%, 15.41% and 22.17% CAGR respectively. Even the returns for SIPs (Systematic Investment Plans) are also good. However, market slumps in recent times have hit the performances of equity oriented funds including ELSS. 

Conclusion

Negative news is flowing across the globe every day. Indian economy is slowing down. The profit margins of the Indian corporate sector are under immense pressure due to high borrowing and raw material cost. There has been a downgrade in 3rd Quarter GDP and the Indian Rupee has depreciated by close to 16% in few months and it is the worst performing currency in Asia. Equity markets (Sensex) have given negative returns of close to 21% year to date. European debt crisis is spreading to major European economies. US economy is also in bad shape. All this has led to a high level of pessimism in the market.

However, the equity market has already discounted the negative news. We believe that there may be headwinds on short term, but long term prospects for equity markets are promising and this could be a good time for investors to get equity exposure for long term, via products like ELSS funds.

Take advantage of market corrections and invest in Tax saver funds! Buy Now

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Disclaimer: iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's scheme information document including statement of additional information. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer on the website.Please read our disclaimer in the website. Risk Factors: Mutual funds, like securities investments, are subject to market risks and there is no guarantee against loss in the Scheme or that the Scheme’s objectives will be achieved. As with any investment in securities, the NAV of the Units issued under the Scheme can go up or down depending on various factors and forces affecting capital markets. Past performance of the Sponsor/the AMC/the Mutual Fund does not indicate the future performance of the Scheme. The name of the Scheme does not in any manner indicate the quality of the Scheme, its future prospects or returns. Please read the Statement of Additional Information and Scheme Information Document carefully before investing.



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