ELSS or Equity Linked Saving Schemes is one of my favorite Tax Savings Instrument. ELSS is a type of Equity Mutual Fund in which you will get Tax benefits under Section 80C of Income Tax Act. ELSS has shortest lock-in period of just 3 years among all the Tax Saving Schemes. Like other Equity Mutual Funds, ELSS also invest in Stock Market specially in Equity segment.
It’s a high risk investment because of equity exposure & returns are not fixed like other tax saving schemes. You can invest any amount in ELSS but tax benefit under section 80C can be availed for max amount of Rs 1,00,000 during Financial Year. Another advantage of ELSS investment is that Long Term Capital Gain or Dividend received from ELSS are Tax Free. To compare performance of various ELSS funds Click Here
ELSS Investment Options
The biggest dilemma for any investor while investing in ELSS is to decide, which option to select from Growth, Dividend & Dividend Re-Invest. In my personal opinion, Growth option is the best option but majority of investor avoid this option as NAV is high in this option. Your personal banker project that Mutual Fund with high NAV is costly and you will get less units. It is very misleading and i will discuss this topic in separate post. Lets understand all 3 options one by one & find out why Growth option is the best one.
1. Dividend option: Normally fund houses declare dividend for ELSS between Jan-Mar of financial year. Its a marketing gimmick and your Personal banker will convince you to invest Rs 50,000 and you will get back Rs 4,000 as a Dividend in few months. USP is by doing net investment of only Rs 46,000, you will save tax on Rs 50,000 as per IT slab.
It is not true as the dividend received within 1 year of investment is taxable. Secondly, Dividend option deplete your investment and is not desirable for long term capital appreciation. Dividend option should be avoided if you wish to invest smartly in ELSS, which i will explain towards the end. Lastly, Dividend in ELSS is not similar to dividend declared in Shares. Dividend declared in ELSS reduce your investment by equivalent amount as NAV will reduce to same extent as the dividend is declared on per unit. If dividend declared is Rs 2 per unit then NAV will also reduce by 2 Rs thus it is your own money which you are getting back as dividend.
In short, its better to rule out Dividend Option.
2. Dividend Re-Invest Option: This is the worst option among all 3 options. Important point to note is that any dividend re-investment is considered as fresh investment in ELSS and is again locked-in for next 3 year. E.g. if i invested 50k in ELSS this year i.e. January, 2014 and selected Dividend Re-Invest option. My investment is locked for 3 years & i can redeem only in Feb, 2017. Assuming MF will declare dividend every year i.e. 3 times in Jan 2015, Jan 2016 & Jan 2017 (It is normal practice for ELSS to declare dividend every year). In this case, Dividend Re-invested in Jan 2015 will be locked for 3 years more years i.e. can be redeemed in Jan 2018. Similarly dividend re-invested in Jan 2016 & Jan 2017 can be redeemed only in Jan 2019 and Jan 2020 respectively…Effectively your partial investment is locked for 6 years from the date of investment.
I think above example is self explanatory to suggest that we should avoid Dividend Re-invest option at any cost.
3. Growth Option: In this option, MF (Mutual Fund) does not declare regular dividends i.e. income earned is not distributed among investors but keep getting added to capital invested. Any upside in investment keeps accumulating thus NAV keep increasing and at the time of redemption only, an investor can book long term capital gain/loss. This option exploit power of accumulation. In my opinion, this is the best option to invest in ELSS. Also by using Growth option, you can invest smartly. Lets understand how.
How to Invest Smartly in Equity Linked Saving Schemes (ELSS)
Every year i have seen my friends getting worried about year end investments to save tax. What if, you need to invest only for 3 years & then no tension of tax investment through out life. I will take my example to explain. I invested Rs 50k every year for 3 years in ELSS in Jan 2004, Jan 2005 and Jan 2006. I opted for growth option and after that i am not at all worried about tax investment. My investment of Jan 2004 matured in Jan 2007 and after redemption, i re-invested 50k in ELSS & balance amount booked as profit. Amount redeemed was tax free and re-investment of same made me eligible for tax benefit under section 80C. Similarly investment of Jan 2005 and Jan 2006 matured in Jan 2008 & Jan 2009 respectively which i re-invested in ELSS same year thus received tax benefits. This cycle is still continuing and by smart investment, i am getting tax benefit every year without any incremental investment from my end. I book the profit and re-invest 50k in ELSS every year.
Word of Caution: In the new draft direct tax code proposed by Govt of India, the tax benefits attached to ELSS are withdrawn. Though final decision is not taken regarding new Direct Tax Code. If it will be implemented on “As is basis” then ELSS will be excluded from list of tax saving instruments.
Some of the FAQ’s:
Query 1: Ms. Sunaina Sharma from Shimla asked me why i have not suggested SIP route to her for ELSS investment.
Answer: Every SIP installment carries a lock-in period of 3 years e.g. If you start SIP from Apr 2013 to Mar 2014 then Apr 2013 SIP installment will mature in Apr 2016 and Mar 2014 SIP will mature in Mar 2017. It is very difficult to keep track of SIP investments in ELSS. At max you should invest only in 2-3 installments during FY at a gap of 3-4 Months but you should avoid monthly SIP.
Query 2: Mr. Swapnil Jadhav from Mumbai asked me, What should be selection criterion of ELSS mutual fund for investment?
Answer: In my opinion, there are multiple factors though there is no fool proof method to identify right ELSS fund. If investment amount is big then you may invest in 2-3 funds to hedge risk. Couple of criterion which i consider are
AUM (Asset Under Management): It shows investors confidence in the fund
CRISIL Ranking: CRISIL rank mutual funds scientifically and i trust CRISIL Ranking.
I tried to cover all the points related to ELSS. Please share you feedback/input/query through following comments section.
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