Dec 26, 2008

ELSS - The Best Section 80C Tax Saving Option

SECTION 80C offers a wide range of tax savings options which includes PF, PPF, NSC, ULIPs, ELSS and SCSS. For a brief over view of various instruments available under section 80C, please read "Section 80C - Tax Saving Options & Investment Avenues".

Equity linked saving scheme (an open-ended mutual fund) popularly known as ELSS is one of most important tax saving avenue made available to tax payers to enjoy the tax deduction under section (u/s) 80C of Income Tax Act, 1961.

Here are 3 reasons why ELSS is considered as the best tax-saving investment option under section 80C:

1. Shortest Lock-in-period
Better Liquidity
ELSS has lowest lock-in (just 3 years) as compared to all other options under section80C. For instance PPF has lock-in of 15 years, NSC has lock-in of 6 years and Bank FDs have lock-in of 5 years.

The initial lock-in period of 3 years make ELSS quasi close-ended. Put another way, it is an open-ended for subscription purposes but for redemption purpose it becomes open-ended only after 3 years of investment.

The lock-in-period of 3 years acts as a deterrent against short term money flowing into the scheme which is a blessing in disguise. The lock-in lends stability to the fund as the fund manager has enough time and freedom to invest and stick to the investment strategy without bothering about redemptions. The fund manager can take a long term view on investments and also avoid frequent portfolio churning. The stability and long term focus helps in generating better returns.

2. Best way to get equity exposure
ELSS is the best way to participate in equities. It is ideal investment option for small investors as it is a simple way of investing in stock markets coupled with tax savings. If you want a taste of equities to boost your overall portfolio returns, there is nothing like ELSS which combines section 80C tax benefit with the returns of the equity funds.

It is quite well known principle in investment that equities tend to perform better than other asset classes over the long term. ELSS is the best option if you have a long term horizon (i.e., willing to invest for the long term) and are comfortable with taking moderate risks (i.e., have the capacity to ride the ups and downs of the capital markets).

Equity linked savings schemes are no different from the diversified equity schemes. What makes these schemes special is that, generally, they tend to out perform other equity based mutual funds. ELSS are in fact better than plain vanilla equity funds because even if the ELSS are able to generate returns at par with other equity funds, they certainly give better returns taking into consideration section 80C tax benefit.

Although conventional wisdom says one should avoid timing the markets, but it pays to enter when the markets are at a low level. The recent correction in the stock market should be used as an opportunity to enter the markets because India’s long term growth potential is no doubt intact. It may take a few months to a few years but sooner or later Indian equity markets are going to bounce back.

3. Potential for high returns
ELSS offers the best returns among all investment avenues under section80C. Almost all other options under section 80C are fixed return instruments and hence there is a ceiling on the returns that can be earned. In most of the cases e.g., NSC, SCSS, 5 YR POTD (Post Office Time Deposits) etc, even the assured interest income at maturity is subject to tax which further brings down the post tax yield.

Over the years, the average returns from tax saving funds far outweigh the returns from all other investment avenues under section 80C. For instance, the five year returns (annualised) of ELSS category are still above 10 per cent even after considering the market meltdown of 2008.

Being equity oriented schemes, ELSS have the potential to provide superior returns (although unlike assured return schemes, returns are not guaranteed) than most of the other options available under section 80C. Besides, those returns are also tax free.

So, don’t waste any more time and wait till the end of the year. First, learn how to prepare a tax savings plan (click here) and in case there is any scope left for further investments, make ELSS your first choice. DO IT NOW. The recent market meltdown offers an opportunity to invest in ELSS at lower levels. With equity markets are trading at such low levels, let me assure you that you won’t get a better chance to SAVE TAX as well as EARN BETTER RETURNS.

If you're finally convinced and would like to invest in an ELSS fund, please read How to Invest in Best ELSS Mutual Funds.

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