ELSS mutual fund – An investor’s delight

Most of the tax saving instruments that fall under Section 80C is saving oriented with returns after adjusting for inflation. The exceptions are the the ELSS (Equity linked savings scheme) mutual funds.

1. What is an ELSS?
ELSS is a mutual fund that has to invest a minimum of 80 per cent in equity shares. The balance 20 per cent can be in debt, money market instruments, cash or even more equity.
There is a 3 year lock-in period for the ELSS mutual funds. Post the 36 months, the funds remain invested and work like any other open-ended mutual fund.

2. What are the advantages?
It is an established fact that in the long run equity gives a much higher inflation adjusted returns when compared to any other investment (except for maybe real estate). The top 5 ELSS funds have given returns from 22 per cent to 26 per cent compounded annually over the past 5 years. This is again higher than the market (Nifty) returns over the past 5 years which is at 19 per cent.

ELSS is part of the Section 80C instruments which are cumulatively eligible for a deduction from income up to Rs.1 Lakh. This gives the tax payers benefits from 10 per cent to 30 per cent (excluding the educational cess) based on their current tax slab.

The return (maturity and the dividend [if opted for]) from the ELSS is also tax free under the present EEE (Exempt–Exempt–Exempt) regime.

The 3 year lock-in period ensures that you don’t withdraw your investments. Generally in a normal mutual fund the tendency to withdraw in case of any monetary requirement is more.

The lock-in period also helps the fund managers to plan their investments better and also to hold on to valuable investments as they do not have to worry about sudden redemption pressures.

The returns achieved by an ELSS fund have consistently been higher as compared to the market returns. Only some sector based mutual funds have given better returns than the ELSS fund in the past 5 years.

3. Which one to pick?
If you are on a tight budget, opting for a monthly investment (SIP using ECS) makes complete sense. The automatic investment from the bank through ECS makes it an easy way to invest.

It is highly advisable to opt for the Dividend Payout option. This is particularly suitable for senior citizens. Also, the ELSS gives a tax free return compared to a bank or company deposit, which is taxable.

4. What are the limitations?
The investment in an ELSS cannot be switched or closed before the 3 years are completed from the date of investment. During market downturns, this becomes a limitation as you can’t do anything much except watch the funds go down. You do have the option of averaging when the market goes down, but an investment to save tax may not be required when the market is on a downslide.

The lock-in works negatively for the monthly investment as well. Since the lock-in period is calculated from the date of the investment and not from the date the scheme was started, the 12th month’s investment can be withdrawn only on the 48th month.

5. What’s the final verdict?
Most fund houses start an ELSS regular investment at Rs.500/- per month. Single investments start generally at Rs.5000/-. This makes ELSS accessible to all tax payers. With the compulsory lock-in giving better returns than other investments, even the most risk averse can look at an exposure to the ELSS fund for their tax benefits.

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