There are a number of elements that go to make up a tax saving instrument. While there are many instruments that help you save tax, they may differ on what else they offer and in what manner. National Savings Certificate (NSC), National Pension System (NPS), Public Provident Fund (PPF), 5-year Fixed Deposits etc are the popular tax saving instruments. But Equity Linked Savings Scheme (ELSS) has proven to be one of the most preferred tax saving options among investors. In the piece below the author tries to explain how ELSS is better than other tax saving instruments. Team RetyrSmart
What makes ELSS the best tax saving instrument?
Let’s discuss what makes ELSS so popular among investors despite the various other options
Shortest Lock-in Period
ELSS funds have the shortest lock-in period when compared to other conventional tax-saving options. In cases where PPF has a lock-in period of 15 years, and retirement schemes (NPS and EPF) which require individuals to stay invested until retirement, ELSS has a lock-in period of only three years. This allows investors access to their funds at a faster rate for any short-term goals. Investors with a long time-horizon can also choose to stay invested to generate higher returns depending on their financial goals.
Return on Investment
Since ELSS funds mainly invest in equity markets and equity-oriented instruments, the returns generated are comparatively higher than that of the other tax-saving avenues. In the same line, equities are the only assets that generate inflation-beating returns over time. When compared to other options such as PPF and FDs, ELSS has always generated a higher return on investment in the long run.
Under Section 80C of the Income Tax Act, 1961, investors can claim a tax deduction up to Rs 1.50 lakh on investments made towards ELSS in a financial year. Though these funds attract long term capital gain (LTCG) tax on income exceeding Rs 1 lakh in a financial year, ELSS is still considered a better option with better post-tax returns.
Systematic Investment Plan (SIP)
Investors who do not have a lump sum amount to invest are also given a Systematic Investment Plan (SIP) facility. The facility allows investors to invest a fixed amount in regular intervals towards the ELSS. This will not only instil a financial discipline but also bring down the burden on your pocket.
Rupee Cost Averaging
Investing in mutual funds through SIP gives investors the benefit of rupee cost averaging. There is no denying the fact that markets are volatile. The performance can either be bullish or bearish. SIP allows investors to accumulate more units during a bear market, increasing the value for money.
Similarly, a bull market would restrict the number of units that can be purchased. Rupee cost averaging allows investors to bring down the average cost per unit during market volatility. The more units you purchase during a bear market, the more return on investment you will be able to generate during a bull market.
Power of Compounding
Compounding means that the return earned on the investment is reinvested to add to the initial capital, which increases your principal/capital for the next compounding period. Your time-horizon also plays a significant role in compounding. The longer you stay invested in the scheme, the higher the benefit of compounding. With ELSS having no maturity date, investors can make the best out of it and generate inflation-beating returns in the long term with the power of compounding.
Investing in ELSS comes with a wide array of benefits. Not only does it allow you to diversify your portfolio but also maximise your profits with tax savings in the long run. Hence, investors are advised to include ELSS funds in their portfolios depending on their financial goals, time horizon and risk appetite.