Equity-linked saving scheme (ELSS), a tax saving mutual fund, is a better investment tool as compared to other traditional tax saving options like PPF, NPS and tax-saving FDs.
The lowest lock-in period, i.e. three years and higher returns makes ELSS a good investment instrument in India.
The tax saving mutual funds can be used by both salaried and self-employed (business) persons to save taxes.
Presently, there are more than 100 tax saving mutual fund schemes (ELSS) provided by several mutual fund houses in India.
This article will help you understand ELSS in a better way and select the right tax saving mutual fund to save taxes with higher returns.
Disclaimer – I do not recommend any particular mutual fund. The mutual funds’ names mentioned in this article are purely for showing how to do analysis. Take your own decision before investing.
Benefits of Tax Saving Mutual Funds (ELSS)
#1. Lock-in Period of 3-years
Tax saving mutual funds have a lock-in period of three years.
The three year lock-in period is the lowest when compared to 5 years of lock-in period in case of tax-saving FD or 15 years in PPF.
However, you should know that the lock-in period starts from the date of purchase. Especially, when you are investing in ELSS through SIP.
Systematic Investment Plan (SIP) allows you to invest a small amount (min Rs. 500) at weekly, monthly or quarterly intervals. Alternatively, you can invest in tax saving mutual funds by paying lump-sum.
For example, if you are investing a lump-sum amount of Rs. 10000 and received 100 units on June 30, 2020. Then the lock-in period will be over on June 30, 2022.
Using SIP you will be investing every month Rs. 1000 and will get 10 units on June 30, 2020, 10 units on July 31, 2020, and so on.
The lock-in period for the first 10 units will get over on June 30, 2022. For the next 10 units, the lock-in period will get over on July 31st, 2022.
But, you should stay invested for a longer duration in mutual funds because on longer horizon equity has the potential to generate higher returns.
#2. Higher Returns Than FD or PPF
Depending on the bank, the returns from fixed deposits are in the range of 5.0% to 7.0%. The present interest rate on PPF is 7.10%.
In comparison to both PPF and FD, the tax saving mutual fund gives a higher annualized 5-year returns in the range of 9% to 14%. However, you need to keep in mind that the mutual fund returns are subject to market risks.
#3. Option to Invest Monthly
Unlike tax saving FD when you invest in ELSS, you are not required to pay a huge amount of money in a lump-sum.
Investments in tax saving mutual funds can be started even for a small amount of Rs. 500 per month through SIP.
#4. Helps Investment in Diversified Assets
PPF and FDs are a type of interest-bearing assets. Whereas, ELSS is a fund that invests a major portion (65% and above) in equities. The remaining part is invested in debt and money market instruments.
The result is you get a diversified investment portfolio. So, you are assured that if one of the assets does not perform well then the same is compensated by gains from other assets.
#5. ELSS are Professionally Managed
You do not have to worry about market research, timing purchase, tracking and managing investment because ELSS has a dedicated fund manager.
The fund manager has professional qualifications and years of experience in managing funds. He is backed by a team of analysts and finance professionals to help him manage your funds.
#6. Can Invest Any Amount
You can invest any sum of money in tax saving mutual funds. There is no restriction or upper investment limit.
However, investment of only up to Rs. 1.5 Lakhs qualifies for tax deduction under section 80C of the Income Tax Act, 1961.
#7. Gains are Partially Taxed
The gains from tax saving mutual funds are treated as long-term capital gains.
You can have tax free returns from ELSS up to Rs. 1 Lakhs. Any returns of an amount over Rs. 1 Lakh are taxed at 10%.
If you want to know other tax savings options then here is the complete list of tax saving options under section 80C.
Tax Savings From ELSS Mutual Funds in India
One can save up to Rs. 46,800 annually in taxes by investing in tax saving mutual funds.
For example, if you fall in the highest tax bracket of 30% and do not invest anywhere for saving taxes then you end up paying taxes on Rs. 1.5 Lakhs (maximum amount of deduction under section 80C).
On the other hand, if you invest Rs. 1.5 Lakhs in tax saving mutual funds, then your gross taxable income decreases to the extent of Rs. 1.5 Lakhs.
The total tax savings on the invested amount will be Rs. 1,50,000 x 30 / 100 = Rs. 45,000.
Additionally, you are not required to pay a higher education cess of 4%. Savings on the cess amounts to 45,000 x 4 / 100 = Rs. 1,800.
Total tax saved by investing in ELSS = Rs. 45,000 + Rs. 1,800 = Rs. 46,800.
Who Should Invest in ELSS in India 2020
ELSS are equity-oriented (invests 65% and above of the portfolio) mutual funds that carry market fluctuations.
The market fluctuations are due to stock price volatility, economic, political and other global factors.
You should choose ELSS if you have a higher risk-taking capacity and are looking for a long-term investment horizon.
Higher risk-taking capacity means that you are ready to take risks for a certain portion of your capital if the share markets move downwards.
For example, ELSS can be chosen by young persons who have just started earning and have a higher risk-taking ability (aggressive investor) and a longer investment period.
People who are risk-averse can look for safe tax saving investment options like FD, NSC or PPF.
On one hand, tax saving mutual funds offer
- A lesser lock-in period of three year
- Potential of earning higher returns
- Partially taxable
- No maximum investment limit
- Not required to have specialized market knowledge
But on the other hand, they are:
- Subject to share market movements and fluctuations
- There are fund charges and fees that reduce overall earnings
Options to Choose For Tax Saving ELSS Mutual Funds in India
Tax saving mutual funds have a growth option, dividend option and dividend reinvestment option to choose from.
#1. Growth Option
In the growth option, all the dividends received are reinvested back into the fund which ultimately increases the Net Asset Value (NAV) of the fund over the period of time.
The increased NAV may result in higher gains that are paid at the end of the period. The risk is that the NAV is also dependent on market conditions.
#2. Dividend Option
The dividend option is helpful in generating regular cash flow because you get a timely payout of benefits in the form of dividends, which are tax-free.
#3. Dividend Reinvestment Option
Under the dividend reinvestment option, all the dividends received are used to purchase additional units in your account. The option lets you increase the number of units thus increasing your overall holding.
The dividend reinvestment method increases the account value faster at no additional purchase cost for you.
Top Best Tax Saving Mutual Funds in India 2020
|Mutual Fund||5 year Annualized return|
|SBI Tax Advantage Fund- Series III Growth||8.52%|
|SBI Tax Advantage Fund- Series II Growth||8.41%|
|Quant Tax Plan-Growth||7.01%|
|Motilal Oswal Long Term Equity Fund – Growth||5.95%|
|Axis Long Term Equity Fund Growth||5.92%|
|DSP Tax Saver Fund – Growth||5.47%|
|Canara Robeco Equity Tax Saver – Growth||5.16%|
|BOI AXA Tax Advantage Fund – Growth||5.09%|
|Tata India Tax Savings Fund – Growth||4.94%|
|Aditya Birla Sun Life Tax Relief 96 – Growth||4.88%|
|Invesco India Tax Plan-Growth||4.74%|
|Taurus Tax Shield – Growth||4.21%|
|Aditya Birla Sun Life Tax Plan-Growth||4.16%|
Disclaimer – The above information is collected from Money Control and should not be treated as a recommendation to invest in any mutual fund scheme. The historic returns indicated here are of May 27, 2020, and are affected by various risk factors.
You should make your own evaluation or consult SEBI registered investment advisers before making any investment decision.
How to Select Best Tax Saving Mutual Fund in India 2020
There is no perfect way to select a mutual fund. However, you can start by analyzing your investment needs (financial goals), investment horizon and risk-taking capacity.
After that, you can check on the following factors before selecting a mutual fund.
#1. Mutual Fund Performance
You should choose a mutual fund scheme that has performed consistently over a long period of time like 1 to 7 years and in various market cycles.
Check previous 1 year, 3 year, 5 year or 7 years performance to gauge consistency or fluctuating performance of the fund.
#2. Exit Loads and Other Overheads
Mutual funds are not supposed to charge entry loads. The overheads and other overheads reduce the overall mutual fund returns. Check for exit load and overhead structures because they reduce the actual returns of the mutual fund.
You should not judge a mutual fund scheme solely based on low exit loads, because passive funds with lower returns charge lower exit loads.
Select a fund that offers a higher return and a reasonable exit load.
#3. Expense Ratio
The expense ratio is the annual fees that include a management fee, administrative cost and other operating expenses charged by the mutual fund scheme.
The expense ratio of most of the mutual fund houses is in the range of 0.5% to 2%. According to SEBI guidelines, the expense ratio cannot exceed 2.5%.
You may pick mutual fund schemes whose expense ratio is lower.
#4. Asset Under Management (AUM)
Mutual fund schemes with high AUM are generally managed by the best and experienced fund managers. A high AUM also gives an idea of the investor’s confidence in the scheme.
However, AUM should not be too large to be managed efficiently.
#5. Fund Manager Performance
The fund manager is responsible for making investment decisions, the timing of purchase and sale, churning and management of the mutual fund scheme.
Experience and expertise play a crucial role in the scheme performance. You should check the fund manager’s past track record by looking at the returns generated by schemes handled by him in the past.
#6. Turnover Ratio
The ratio indicates the frequency with which the fund holdings have changed in the past years.
A simple formula to determine turnover ratio is by dividing the lesser of purchase/sale value by the average AUM (Assets under management).
For example, suppose a fund purchased Rs. 300 crores of shares and sold Rs. 200 crores of shares and the average AUM of the fund was Rs. 1000 crores.
In the above case, the turnover ratio is 200 / 1000 = 20%. This means that 20% of the portfolio got changed during the last year.
A low turnover ratio indicates a passive investment strategy that lowers the expense ratio. On the other hand, a high turnover ratio indicates aggressive trading which will increase the expense ratio.
ELSS is a better tax saving option for aggressive investors. They offer you a host of benefits like higher returns with the lowest lock-in period of three years.
You get to invest in a diversified portfolio, have a dedicated fund manager and the flexibility to invest at monthly intervals. Overall, ELSS helps you effectively plan and manage your taxes.