The case for ELSS funds: Get paid to save tax

Source: The Hitavada      Date: 19 Mar 2018 10:45:30


Its time for us to repeat our annual article dealing with tax saving. Last year, at exactly around this time, we had written this piece and all those who did invest in ELSS are today reaping the benefit. So for this year, here goes. We are in the last month of the fiscal year – which means it is the last month for any tax saving to be undertaken for FY 17-18. As we all know, Sec 80C under which one can invest Rs 1.50 lakh for availing of the tax deduction spoils investor for choice. Right from the provident fund contributions out of salary to PPF, NSC, Post Office Time Deposits, Bank FDs, Senior Citizen Saving Schemes and even insurance premiums qualify for deduction.

If you notice, we haven’t mentioned tax saving funds – also known as ELSS funds. The reason for this is that most investors tend not to opt for this product on account of the perceived risk. And those who do opt, once gain, generally tend to invest only a part of the available Rs 1.50 lakh in ELSS, reserving the balance for other fixed income products. In other words, mutual funds are perceived to be risky – for most investors, any investment in equity or equity related products is the ‘risky’ part of the investment portfolio. For tax saving purposes, the same cannot be used and instead the regular fallbacks such as PPF, NSC, Bank/PO FDs etc. are instruments of choice.

However, perhaps such thinking needs a change in perspective. For, no one will argue against the fact that equity presents the best option for building wealth over the long-term. The problem is people don't want to undertake the risk of capital loss over the short-term for the sake of appreciation over the long-term. But let’s take a step back and think about it. Say you are in the 30 per cent tax bracket (ignoring surcharge / education cess etc) Now what this means is that the moment you invest Rs 1.50 lakh in an ELSS fund, you get a return of 30 per cent!! Putting it differently, being in the 30 per cent tax bracket, you will not have to pay tax of Rs 45,000 due to your investment of Rs 1.50 lakh. In other words, you have earned Rs 45,000 the moment you invest Rs 1.50 lakh. So the capital loss, if any, will only take place if the market (and your investment along with) were to fall by over 30 per cent hereon.

As we write this, the Sensex is at 33,176 points. A 30 per cent fall from here would mean a Sensex level of 23,223 points. Therefore, if and only if the Sensex were to fall to a level below 23,223 will you actually incur a capital loss. While theoretically it can happen, the possibility is at best remote. On the other hand, over the next three years, the possibility of the market going higher is more plausible than the other way around. And if this happens, your return would obviously be higher than 30 per cent!!

Now, the 30 per cent tax saving translates into an immediate return but any ELSS investment has to be held for at least three years. So, the correct way of looking at this will be to spread the 30 per cent over three years. This would assume that the market remains flat throughout, neither does it fall not does it rise. In such a case, the rate of return for a person in the 31 per cent tax bracket would be 12.6 per cent (it is not 30 per cent divided by 3 years, one has to take compounded growth)Perhaps your immediate reaction to the above argument would be that this so called 30 per cent yield due to the tax saving is not limited to an ELSS investment -- one can benefit of the same from any investment that saves taxes like say PPF, Bank FDs, or any of the other instruments enumerated in the first para. Quite true. However at this point we will like to take you back to the fact that over the long-term, equity has the potential of delivering the highest return.

So, say over a five year period, an ELSS fund should give you a much better return than Bank FD or Post Office deposit. For example, as a category, the 1-year return of tax saving funds is in the region of 32 per cent, the 3-year and 5-year figures are 12 per cent pa and 19 per cent pa respectively. So basically, investing in an ELSS fund is akin to saving tax and getting paid for it. So hurry – time is running out for this fiscal.

(The authors may be contacted at [email protected])