Why should salaried class look at ELSS?

There are several provisions in the Income Tax Act wherein salaried individuals can save taxes, but Section 80C of the Income Tax 1961 Act provides the biggest tax saving opportunity. Salaried individuals can claim up to Rs 150,000 deduction from taxable income by investing in specified schemes u/s 80C. Salaried people must aim to maximize their tax savings by investing in 80C schemes.

The most important personal financial goal for salaried class is to achieve financial independence. Wealth creation is the single most important ingredient in the recipe for financial independence. Savings and investments in 80C instruments can help achieve this.

ELSS has provided superior returns - There are a number of eligible investment options which qualify for tax benefits u/s 80C. Some investment options like Public Provident Funds (PPF), National Savings Certificates (NSC), Tax Saving Term Deposits (offered by both banks and post offices) etc. Equity Linked Savings Schemes (ELSS) and Unit Linked Insurance Plans (ULIPs) are subject to market risks.

In the last 15 years (ending 25th October 2019), Public Provident Fund (PPF), which is one the most popular traditional tax savings schemes, gave 8.5% annualized returns. Over the same period Nifty 50 TRI, the benchmark index of the 50 largest stocks by market capitalization gave 14.8% annualized returns. The interest rates of Government small savings schemes u/s 80C (e.g. PPF, NSC, PO Tax Saver Deposits etc.) and bank tax saver FDs were much lower compared to ELSS returns over the last 15 years (source: Advisorkhoj.com, as on 31st October 2019).

ELSS can help achieve financial goals - Your tax savings investment should not just be about saving taxes, it should also generate sufficient returns to create wealth for your medium to long term financial goals.

Let us now take forward looking perspective. The traditional tax savings investment options are currently offering interest rates in the range of 7.5 – 8%. ELSS funds invest in equity and equity related securities, across different industry sectors and market capitalization segments. It is not possible to guess with any sufficient degree of accuracy, returns of equity investments in the short to medium term. However, historical equity asset class performance across different market conditions (rising and falling markets) can provide some sort of guidance for the purpose of different asset class comparison. Over the last 15 to 20 years, the average rolling returns of Nifty 50 TRI over 5 year investment tenures, across different market conditions is around15% CAGR (source: Advisorkhoj.com, as on 31st October 2019).

Option of saving systematically in ELSS Funds - The monthly salary provides a sense of financial security; it takes care of your regular expenses and lifestyle needs. However, there are important life-stage goals which will require large cash outflows, e.g. home purchase, children’s higher education, children’s marriage etc. You need to plan and save for these important goals. To help meet these goals, you can invest in ELSS funds every month through Systematic Investment Plans (SIP). You can choose a date immediately after your salary payment day and set-up an auto debit for the amount that you want to invest every month in an ELSS fund.

The table below shows the wealth created through monthly Rs 10,000 Systematic Investment Plan (SIP)in Nifty 50 TRI over various tenures (ending 25th October 2019).

TenureCumulative InvestmentMarket Value of Investment Annualized Return (XIRR)
Add 3 years
5 years600,000778,81810.4%
7 years840,0001,258,39611.4%
10 years1,200,0002,138,25811.1%
15 years1,800,0004,676,03611.8%

Source: NSE data as on 25th October 2019

Source: NSE data as on 25th October 2019 While historical returns may not be the most accurate indicator of future returns, the historical 5 year rolling returns of Nifty provides a sense of the difference in wealth creation potential of equity (Nifty) versus fixed income asset class. It should also be informative for investors to note that ELSS mutual fund schemes are actively managed by professional fund managers, who are tasked with beating market returns. Therefore, if you have invested in ELSS with a long investment horizon in mind, you may get better than market returns on your investments.

ELSS has the least lock-in period - ELSS is also one of the most liquid investment options u/s 80C with lowest lock-in period of 3 years. Compared to this, PPF has a minimum tenure of 15 years (partial withdrawal after 7 years) and NSC/Bank FDs etc. has minimum 5 years tenure. You can redeem your ELSS units partially or fully after 3 years. However, you should redeem your ELSS Funds according to your financial needs only.

ELSS investment is tax efficient

Long Term Capital gains in excess of Rs 1 lakh from sale of ELSS units are taxed at 10%. Dividends paid by ELSS are tax free in the hands of the investor but Mutual Funds have to pay 10% Dividend Distribution Tax before paying dividends to investors.

Summary

Tax savings should be one of the most important annual financial goals of the salaried class. ELSS may help salaried households not just with tax savings but with wealth creation on a post-tax basis over long investment horizons.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.

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