Understanding the tax saving advantages and returns of ELSS mutual funds
This article is authored by Tejas Gutka, Fund Manager at Tata Mutual Fund.
As young professionals embark on their careers, prioritizing long-term investments becomes crucial. While short-term goals hold appeal, planning for the future is equally important. The Indian Income Tax law incentivizes this by allowing tax deductions for specific investments up to a limit (currently Rs 1.5 lakh under Section 80C). This translates to a tax reduction by investing up to Rs 1,50,000 in various tax-saving instruments each year. These investments not only aid in long-term financial goals like retirement but also lower the tax burden.
An Equity Linked Savings Scheme (ELSS) is a mutual fund scheme that qualifies for tax deductions under Section 80C. It invests in equity and equity-related securities, making it a unique option within Section 80C. Historically, equity has outperformed many other asset classes over extended periods. Millennials, with their long investment horizon, can leverage this by investing in ELSS funds and potentially benefit from the potential outperformance of equities.
Another benefit of ELSS funds is the relatively shorter lock-in period. To avail the tax benefit, ELSS comes with a 3-year lock-in, offering liquidity after this period in case of emergencies. While the option to withdraw after 3 years exists, the true benefit of equity investments lies in the long term.
As the saying goes, there's no such thing as a free lunch. This applies to tax-saving investments as well. Equity returns, while historically positive, are not guaranteed. They can fluctuate significantly year-on-year, ranging from positive to negative. However, it's important to note that volatility tends to reduce over time. The longer the investment period, the less the returns deviate from the average. Therefore, focusing on the long term (beyond a 3-5-year horizon) is crucial for ELSS investors.
ELSS, as a tax-saving investment, aligns well with the goals of young investors. Their long investment horizon allows them to potentially benefit from the historically superior returns offered by equities compared to other asset classes. However, factors like taxation, market volatility, and expenses can affect returns.
While these considerations might seem overwhelming for beginners, consulting an investment advisor can be beneficial. Ultimately, investors should evaluate investment options not just based on returns, but also considering their individual goals and risk tolerance. Diversifying their portfolio and aligning choices with long-term objectives are key aspects of balancing risk and returns.
Disclaimer: The opinions expressed above are personal and may not reflect the views of DSIJ