Why tax-saving mutual funds are the best way to save on taxes

You can’t grow long term if you can’t eat short term; one can always manage short and long-term goals as independent as it can be. The art lies in balancing both your short and long-term goals successfully.  Many of us plan our retirement and needless to say it’s one thing that isn’t in our list of things. We focus on saving tax every year, but we need to better manage it to achieve our long and short team goal. Tax saving should be done in two parts i.e. first save tax for the year and next, invest in funds for your retirement.

So the next question obviously is, do we have instruments that will help us save tax and plan our future. Yes, we have an equity-linked saving scheme or as we call it ELSS of mutual funds.  In Income Tax Act, under Section 80 C, one can invest up to INR 1.5 lakh for a financial year. One can always invest more than INR 1.5 lakh, but it won’t qualify for tax benefit.  There was a recent announcement that the return generated from ELSS will become taxable with the dividend distribution tax and taxes on the long-term capital gain. In spite of the changes, it’s a good option for young earners who are starting to save for retirement and tax. The benefit of ELSS is short lock-in period and provides the potential for growth via equity.

Understanding Equity Linked Saving Schemes

ELSS is equity diversified mutual fund scheme with a lock-in period of three years from the date of investment. Post completion of the lock-in period, the scheme turns into an open-ended scheme and one can withdraw the fund. It’s better to keep the funds invested considering your long-term goal of retirement. These funds are managed by fund managers who are experienced finance professionals with a better understanding of the benefits of tax saving, plus are offered by fund houses. It’s important to decode why ELSS is a better investment under Section 80 C to save tax.

Types of ELSS

ELSS has two main categories of funds i.e. Dividend and Growth fund.  Dividend Fund is further subdivided to Dividend Payout i.e. you will receive the dividend tax-free and Dividend reinvestment i.e. your investment will be reinvested as a fresh investment. Growth Fund provides long-term wealth creation platform for investors where the full value of the fund is realised at the time of redemption.

How ELSS is better than all other 80C Investments             

ELSS still is considered one of the best options to invest even though the returns are being taxed as per the new guidelines.  Returns attract long-term capital gains from ELSS, but they should still continue to be part of your investment portfolio as per the industry experts. These are equity-based investment instruments that provide the potential of higher returns considering the long-term scenarios. In comparison to other investment options like PPF and ULIPS, post-tax returns are better for ELSS.

Short lock-in period: This is one of the attractive aspects of investing in ELSS in comparison to other tax saving investment option. The lower lock-in period is beneficial to an investor. Whether it is Public Provident Fund, Employee Provident Fund or National Saving Certificate (NSC), all required a minimum lock-in period ranging from five to fifteen year where ELSS stands at a minimum of a three-years.

High Returns on Investment (ROI): We all invest to gain profit, increase our savings and of course, hopes to fulfil our aspirations. Since ELSS is invested in equity markets, the returns are much higher than other investment options.  While we save tax, these profits earned in long run is a better option of investment in Section 80 C with a focus on not too short or mid-range of investment duration. Public Provident Fund provides eight percent returns, while ELSS can generate anything in the range of ten to twelve percent in a period of ten plus years. The returns from NSC and other life insurance schemes are also less than of ELSS.

Flexibility with ELSS:  ULIP’s don’t provide flexibility of ELSS; in case we are not okay with the ELSS fund, one can always moved to another fund since there is no multi-year commitment. With ULIP non-performance, one can move or invest in funds that are offered only that ULIP. It’s true that ULIP can also provide similar returns like that of an ELSS and are sold at a low cost by insurance firms directly.

Benefit of Combining ELSS and PPF: This is a solid combination since together, they cover the stability of PPF and earning a potential of ELSS.  The next advantage is that you combine debt and equity both in your investment portfolio with government-backed security and opportunity of growth through fund house.

 Protection in times of volatility:  Since the lock-in period if of three years, it helps to build a discipline and stay away from fear of changing your fund house too frequently.  In terms of changing market’s, they act as a strong shield to weather the volatility that comes with investing in stock markets. In simple terms, it enjoys the benefits of market high and has provisions to reduce the impact of marker low.

Things to know about ELSS before you invest

Before we even start with our selection of ELSS, tax saving mutual funds, one should know how much to invest, duration and the objective of the investment i.e. is it for saving tax or your retirement or your dream house goals?

Look at your earning, spends and time frame to achieve your goal, inflate the expenses and see how much surplus you have to start investing.

Selecting your ELSS isn’t a simple task since we have multiple options like Large Cap, Mid Cap or Multi-Cap Stocks. It will be good to diversify across on not more than 2 to 3 ELSS with variation in industry and market capitalisation.

It is crucial to consider all facts about the fund and your financial objective before investing. One should keep reviewing the performance of schemes after the lock-in period is completed. Don’t look at funds in isolation, look at its benchmark return with consistency to beat its benchmark and at the category average returns will tell how good or bad is your investment against its peers.  Don’t look at a short-term run; incentivise your long run by balancing your investment goals.