Towards the end of the financial year, most of us start chalking out our tax plans, or the lack of one. If you are a salaried professional, you might get a reminder from your accounts department and if you are self-employed, your accountant would remind you to ‘do your taxes’. Either way, it ends up being at the eleventh hour.
While some of us may have done the smart thing by planning early, the majority might have not. However, this is merely a ‘tax saving’ exercise and cannot be called ‘tax-planning’. Tax planning is all about planning in advance, which involves evaluating your overall tax strategy and implementing it before the year-end. In this way, you can make the most out of your tax saving opportunities, which would eventually help you accumulate wealth over the long-term. Tax Planning is an essential part of financial planning and deserves the rightful time and effort.
So when we think about tax-saving as a goal, various options come to mind, that qualify for deduction under Section 80C of the Income Tax Act, 1961, which allows deduction up to Rs. 1,50,000.
The answer however varies, from person to person, objective to objective, and as per the risk appetite. However, it is important to look at not just the tax saving criteria but also its potential to generate returns that would beat inflation in the long term.
One such investment avenue that aims to provide both, tax saving benefits as well as a relatively higher growth potential, is Equity Linked Saving Schemes.
What is ELSS?
Equity Linked Saving Schemes (ELSS) is an equity mutual fund scheme which has a lock-in period of 3 years. ELSS as the name suggests invest predominantly in equity and equity related securities and is managed like any diversified equity scheme, However, due to the comfort of a minimum lock-in of 3 years the fund managers can invest with a longer term view without having to worry about daily inflows and outflows from the fund.
Why ELSS?
As compared to other investment avenues, ELSS provides the lowest lock-in period and relatively higher potential for returns due to its linkage to the equity markets.
Some of the main advantages of ELSS are as follows:
- Investment in ELSS could provide capital growth over the long term since they invest in the equity market.
- ELSS mutual funds invest primarily in equities, and equities over a longer time frame have the potential to outperform traditional instrument like NSC and PPF.
- ELSS has the lowest lock-in period of 3 years as compared to other investment avenues
- Investor can opt for dividend option which could help generate income even during the lock-in period.
Disadvantages of ELSS
Being an equity-oriented product, ELSS are susceptible to market volatility. However, due to its lock-in feature some amount of risk is mitigated over a period of time. Premature withdrawal is not allowed but it is allowed in other instruments in some specific conditions.
Investing in ELSS through Systematic Investment Plan (SIP)
One of the preferred ways to invest in ELSS is through Systematic Investment Plan (SIP). SIP helps an investor to take advantage of the fluctuations in the stock markets by a method popularly known as rupee cost averaging. Rupee cost averaging is a process through which, an investor puts in a fixed amount of rupee at pre-determined intervals. Thus, with the invested amount, more units would be bought at a lower price, whenever markets go down and lesser units will be purchased at a higher price. Over a period of time, this method is observed to result in an average cost of acquisition which is lower than had the investor bought all the units at one go.
The main advantage of investing through a SIP route is that it helps in keeping emotion under check and the onerous task of timing the market accurately is also done away with. As has been observed a normal investor backs out when the markets are falling due to panic, he won’t be buying and this will not get him to average his price, the primary reason for which a SIP is recommended. The money invested in ELSS gets invested in equity markets wherein, market ups and downs happen over a period of time. Thus, investing through SIP in ELSS and staying invested would be the ideal way to ride the market ups and downs and build wealth in the long term.
Overall, ELSS is a good investment vehicle to save tax as well as to grow your investments over the long term. You could reap better returns from appreciation in equity markets over the long term. You can also choose the SIP route to avoid ups and downs of markets. If you really want to reap the rewards of your tax saving investments, think beyond the lock-in period of three years. Over the long-term, equities may relatively deliver higher returns and aid capital growth.
“Make tax saving a habit, not a last minute rush. Invest in the ELSS vehicle to save tax as well as create wealth over the long term! ”