When it comes to tax saving, the equity-linked savings scheme (ELSS) is one product to consider as it can give good returns. ELSS are diversified equity mutual fund schemes that provide tax benefits under Section 80C of the Income-tax Act, 1961, up to Rs 1.5 lakh. The schemes have a three-year lock-in during which they cannot be redeemed or switched.
In fact, ELSS has been rated as the best tax-saving instrument for the long term when compared on the basis of return potential, tax benefits and taxability of maturity proceeds. ELSS not only helps you save tax up to Rs 46,000 per year under Section 80C of the Income Tax Act 1961, but also it helps you multiply your wealth in the long term.
Selecting the right ELSS is very important. Selecting the previous year’s best performer is probably not the best way to select an ELSS as different strategies and styles work in different market situations. If you are looking to invest in ELSS for tax saving purposes, you need to select the scheme based on your comfort with the portfolio strategy, stock concentration and not based on just the historical returns alone.
ELSS scores over other competing products like ULIPs, NPS as it has a shorter lock-in period of three years and maturity proceeds are subject to long term capital gains tax at 10%. However, long term capital gains of up to Rs 1 lakh in a financial year are exempt from tax. Many people invest in ELSS funds because of the shorter lock-in period and they withdraw the amount after the lock-in ends.
It is important to remember that even though the lower lock-in period for ELSS of three years is often considered an advantage in comparison to other tax-saving products that have longer lock-in periods, you should ideally look at a longer period of holding in order to benefit most from appreciation in equity investments. Sometimes a three-year period may not be adequate for the markets, especially the mid-cap and small-cap segments, to reverse a downward trend and generate returns.
On the other hand, if you stay invested in an ELSS scheme for a longer period you can reap handsome returns. Typically, ELSS funds are flexi-cap funds. It means these funds have the flexibility to invest in companies of all sizes (based on market capitalisation) without any restriction on any sector. Additionally, being a flexicap fund, ELSS funds get the flexibility to change their portfolio as per the economic cycle and market conditions which is why these funds have the potential to deliver higher returns in the long term.
As per general calculations, if you stay invested in an ELSS fund for a period of 10-20 years you can easily expect a compounded return of over 10%. According to mutual fund research website Value Research, 10-year average returns of ELSS schemes is more than 12% as on January 25, 2021).
Going by the above estimates, if you invest Rs 1.5 lakh in ELSS schemes every year (or Rs 12,500 every month) you can save up to Rs 46,000 in tax (based on your tax slab) and accumulate a corpus of Rs 1.25 crore in 20 years assuming a CAGR of 12%. Even if you reduce the CAGR expectations to 10%, you can accumulate a corpus of Rs 96 lakh in 20 years by investing Rs 1.5 lakh annually. Not only can you save tax efficiently with ELSS, but you can also get a large corpus by the end of it. However, take note that in the case ELSS, returns are not guaranteed as it is a market-linked product.
