Are you one of those who consider tax planning as the end of the year activity? And do you also consider tax saving instruments to be one with long lock in periods where you cannot touch your money? If yes, you need to change your perception. It is always said that a portion of our surpluses should be into equities to beat inflation. The same applies in case of tax saving instruments too. While direct equity is risky and the lack of knowledge can make you burn your fingers, it is advisable to take mutual fund route. The latter brings expertise of the fund manager to the table.
There is plethora of equity mutual funds available, but one that stands out in terms of tax efficiency is equity linked saving scheme (ELSS). It provides tax relief under section 80 C of the Income Tax Act. Like other equity funds, it invests 65 per cent of money in a basket of stocks thus making it diversified. But unlike fixed deposits it does not come with guaranteed returns. The return of the scheme depends on the performance of the broader market and the fund manager’s ability in picking up the stocks. There could be lot of volatility in the short term. But over a longer period of time, it tends to do well. In fact, in the past one year scheme like HDFC Tax saver has given a return of around 60 per cent while Reliance Tax saver has thrown gargantuan 82.8 per cent return. What is to be kept in mind is that an ELSS scheme is an open-ended one. This means investors can subscribe to it any time. However, the NAV of the same is declared on each business day.
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You must remember that ELSS comes within a lock in period of 3 years unlike other kinds of mutual funds which can be redeemed any time. This means you cannot redeem your money in these three years. The lock-in gives fund manager the advantage of managing the funds as per his intelligence as the amount remains blocked. The lock in period, which is the shortest help ELSS score over other tax saving instruments. Public Provident Fund (PPF), National Saving Certificates (NSC) and fixed deposits’ maturity range from 5 years to 15 years. Another advantage is that you can remain invested in this scheme beyond 3 years if you wish to and gain from the price appreciation in the market.
Options within ELSS
There are various options within ELSS to choose from. First option is the growth one. Here the income earned by the fund is not distributed to unit holders in the form of dividend. However, the profit earned by the fund leads to increase in its NAV and any loss means reduction in the same. Whenever the investor sells its holdings he will realize long term capital gain and loss. Second option is dividend option wherein the fund distributes income earned by the fund to the investors as dividends. The date of distribution is declared by the fund. However the fund is not mandated to declare dividend. If there is negative income, it will not distribute any dividend. Any dividend received by the investor is not liable for tax in the hands of investors.
The third and the last option is Dividend reinvestments option. Here the dividends declared by the fund are reinvested in the fund itself. For example an investor is holding 5000 units of a fund and the fund declares dividend @ 1 per unit, the total dividend of 5000 (50000*1) will be reinvested on behalf of the investor. It will be treated as a fresh purchase. Also, the investor can claim deductions to the tune of dividend received.
You can invest with as low as Rs 500 and take this to a maximum of Rs 1 lakh. You claim deduction up to the same from your gross total income under section 80 C of the Income Tax Act. This is not all. The returns from an ELSS scheme are tax free. It enjoys the exemption on long term capital gains. Dividend income too is tax free.
Lumpsum or SIP?
Investment in ELSS can be made in two ways-lump sum or through SIP route. Investing at one go and that too a large amount is bit difficult. Therefore,monthly investments on a pre specified date in mutual funds can be made through systematic investment plan (SIP). It averages out the cost of investors. As the amount of investment is fixed the units purchases every month varies depending upon the NAV of the fund. At a higher NAV the investor gets fewer units and more number of units at a lower price thus averaging out the cost of investors. However, an SIP in an ELSS can prove to be very cumbersome. Each SIP of the ELSS has to individually complete 3 years to get over the lock in period. For instance an SIP of Rs 2000 made at 1st April 2014 can be redeemed only on 1st April 2017. The next SIP made on Ist May 2014 would complete three years on Ist May 2017 and so on. For SIP you can give an ECS mandate to your bank or submit post dated cheques. This way money would keep flowing to your ELSS fund every month.
How to apply for ELSS?
Applying for an ELSS is quite easy. As an investor you need to comply with Know Your Customer regulations (KYC). This entails sharing personal details like PAN no etc to help prevent fraud of any kind. You have to submit the form, sign it and attached a cheque leaf to it.
How to zero in on an ELSS schemes?
Past performance: You should look at past performance of the fund but not blindly. Usually we all with go with the recent chart topper. However, its not true that past good performance would be repeated by the fund again. So be little judgmental while choosing a fund based on past performance. Do not keep this as the sole criteria in selection. For deciding about the best ELSS scheme to invest in, you should look at long term performance of say 10-15 years. Also remember that all ELSS funds aren’t the same. While some have small and mid-cap bias, others don’t.
Consistency: If you are looking for past performance, look out for consistency. It is most important. Don’t get carried away by the one-time returns. See if the fund has been able to generate the similar return year-on-year.
Go with the ratings: Another way to choose ELSS funds is to considers ratings published by various agencies and publications like Value Research Economic Times and Outlook Money. You must go for a minimum rating of 4 or 5.