January. February. March.
Every year, these three months showcase a unique behavior among us Indians.
The frenzy to avoid paying tax.
Or at least, minimize how much money we hand over to the government.
Everyone’s looking for investment advice or a quick tip to help them save tax. Insurance policies, mutual fund investments, PPF, the list goes on.
For financial institutions, this is their busiest time. All you need to sell a product are those two magical words – save tax!
In this post, I touch up ELSS (Equity Linked Saving Scheme) mutual funds. By presenting some of the facts about ELSS mutual funds, I hope you get enough insights to take a decision.
Should I invest in ELSS or PPF?
Here’s a fun assignment for you.
Ask any firm that sells mutual funds – should I invest in PPF or ELSS?
I’m sure they’ll give you point by point explanation of how ELSS is better. Lower lock-in, higher returns etc. They’ll probably even have an article on their site with comparison tables.
Now, pick a poorly performing equity mutual fund they have to offer. Ask them why you should invest in the fund while a FD, which is guaranteed, has comparable returns.
They’ll most likely tell you that it’s an apple to oranges comparison. Equity is a different asset class and you should not compare it with a fixed income product like FD.
See where this is going?
The investment firms will compare PPF, a fixed-income guaranteed product with ELSS, an equity-linked product without any guarantee. However, when it’s hard for them to make a sale, they will tell you asset classes should not be mixed up when comparing.
What gives? Why the double standard?
Incentives. When they sell ELSS mutual funds, they get commissions. Since ELSS comes with a 3-year lock-in, they are pretty much guaranteed a 3-year commission.
The popularity of ELSS is usually driven mostly by distributors and media. Not because it’s the best investment option for you.
When to invest in ELSS mutual funds?
There’s definitely a place for ELSS mutual funds in your portfolio. Here are some of the times you can pick them.
#1: You want to get your feet wet by participating in the equity market
When you are starting out, ELSS can be a great choice.
ELSS funds serve the dual benefit of helping you save tax as well as participate in the equity markets.
#2: Most of your non-tax saving investments are in fixed income
Your portfolio should have a healthy percentage invested in the markets. That’s how you grow your wealth.
If you have a huge fixed income allocation through bank FDs, PPF, etc. then, you can add ELSS investments to your portfolio.
#3: You are older without guaranteed government pension for life
Most people will tell you that when you retire, most of your investment should be in fixed income.
If you have a guaranteed lifelong-pension from the government, maybe that advice will work for you.
However, if you do not have a guaranteed pension for life, you should still have equity investments in your portfolio. With advancement in the medical field, you could very easily live to cross the 100 mark.
And 100% fixed income investments are not going to generate enough interest every year for you to survive till you are 100.
If you have taxable income during retirement, use ELSS to save tax + participate in the market. Since ELSS has a lower lock-in, it provides better liquidity for retired people.
When not to invest in ELSS?
#1: You are confused which fund to invest in
Fund selection is mostly a game of luck.
Most investment providers and banks will have you think otherwise. That there is some magic sauce they have to help you pick the right investment product.
But here’s the thing.
That’s just marketing ploy.
#2: You have already maxed out your 80C investments
Think about ELSS only if your EPF contribution, home loan payments, and child’s education fees in 80C, combined, do not hit the maximum limit.
#3: You have an investment duration of fewer than 10 years
ELSS is by definition an equity-linked scheme. And equity markets are for the long-term.
Investment firms will recommend that you invest in their equity funds for the long term. However, the same firm will try to sell you ELSS citing the shortest lock-in among all 80C tax saving options.
Unless you plan to invest for 10+ years, do not invest in ELSS.
Of course, exceptions apply as always. But don’t make it the norm.
#4: You can’t stand to lose 50% of your investments
Equity markets swing up and down. Sometimes without any logic. That’s just how markets behave.
If another crash like the 2008 or the 2001 dot-com bubble happens, you can lose 50% or more of your investment’s value.
If you cannot handle such volatility, you should not invest in ELSS. Participate in a normal equity mutual fund schemes where you can pull out money and keep in cash during highly volatile times.
Due to the very definition of equity mutual funds, most funds have to keep 65% of their investments in equity – even if it’s not ideal. ELSS is no exception.
My simplified tax saving plan
I used to invest in ELSS mutual funds. With my current employer, my salary is structured in a way that my 80C requirement is mostly taken care of by my EPF contribution.
In addition to my employer’s health insurance coverage, I have a Rs 15 lakh medical insurance cover for me. This helps me save tax under section 80D.
I do not invest in life insurance policies, ELSS, or other such products to save tax.
If I didn’t have my current salary structure. I’d have gone for a PPF account to max out my 80C.
From a tax perspective, is PPF or ELSS better?
Earlier both PPF and ELSS had EEE (exempt-exempt-exempt) status. This meant that the investment, the gains/interest, and the withdrawals were tax-free.
With the introduction of LTCG (Long Term Capital Gains) in 2018, ELSS has lost the EEE status. Now, withdrawals will be subject to LTCG tax rules.
However, since ELSS is an equity-linked product, even with LTCG, it has the potential to deliver returns above PPF.
Over To You:
Do you invest in ELSS to save tax? Share your views below.