Equity Mutual Funds

Reasons to Opt for Mutual Fund for Tax Saving

The re-introduction of the long-term capital gains (LTCG) taxes on equity, funds have made investors a bit jittery. A lot has been written and said already about the impact of LTCG on equity and related schemes.

In this blog, we seek to discuss why you should include mutual funds for tax saving purpose despite the re-introduction of LTCG.

Read on!

The basics of Tax Saving Mutual Funds

The Equity Linked Savings Scheme (ELSS) has provided relief for the middle-income people, particularly the working class. At a time, when inflation has been rising, you must choose investment options that provide tax benefits and also beats inflation at the same time.

For example, if the returns on a tax saving mutual funds are 9% and if the inflation of the economy is 6%, the net returns you are making is only 3%. Such small returns don’t make sense for an investor as it doesn’t allow for accumulating wealth.

ELSS, in this scenario, has been a favorite product as it has generated annualized returns over 20% over the long-term and comes with a lower lock-in period of three years.

Following are the key benefits of investing in an ELSS –

Minimum Lock In Period for Mutual Funds (ELSS)

Majority of the tax-saving instruments come with a lock-in period that varies from 3 years to 30 years. During the lock-in, an investor is not allowed to redeem investments or make emergency withdrawals. When comparing all the investment options, ELSS currently has the minimum lock in period for mutual funds at three years. This enables an investor to shift the investments to better alternatives or a safer alternative when required.

  • Public Provident Fund (PPF) has a lock-in of 15 years
  • Tax saver fixed deposits (FD) has lock-in of 5 years
  • National Savings Certificate (NSC) or the Kisan Vikas Patrika (KVP) has lock-in of 6-8 years
  • Sukanya Samriddhi Scheme (SSS) has a lock-in of 21 years
  • Senior Citizen Savings Scheme (SCSS) has a lock-in of 5 years

Flexibility with the investment period

The flexibility offered by mutual funds can’t be matched to other options. In the case of ELSS, while the minimum lock-in is three years, it is not mandatory that you need to redeem your investments after lock-in as no subsequent lock-in starts upon maturity. If, as an investor, you see that the ELSS fund is providing healthy returns at the desired risk level suiting your appetite, you may choose to remain invested for an extended period of 10, 20 years or even more.

Market linked returns better than traditional instruments

ELSS is a market-linked product and provides exposure to the capital market. Owing to this, the returns offered by ELSS is superior to other products such as the PPF, SSS, Tax saver Fixed Deposits, NSC, and the likes which invests in safer instruments such as government bonds, etc.

ELSS vs. Traditional Products

Let us compared ELSS with other conventional products such as PPF, NSC, and others.

Investment Approximate returns Lock-in period Tax on returns Risk Profile Guaranteed Returns
ELSS 14-16% 3 years No Equity Linked No
PPF 7.5-8.5% 15 years No Risk Free Yes
National Pension System (NPS) 8-10% Till retirement Yes (partially) Equity Linked No
NSC/KVP 7.5-8.5% 5 years Yes Risk Free Yes
FD 7-9% 5 years Yes Risk Free Yes
Unit Linked Insurance Policy 8-10% 5 years Yes Equity Linked No
SSS 8-8.5% 21 years No Risk free Yes
SCSS 8-8.5% 5 years Yes Risk free Yes

Source: Tarrakki Research

What should an investor do?

It goes on without saying that there is a benefit of using mutual funds over conventional products, but that shouldn’t be the base to conclude. Given every individual is different and has a different need, it is essential you first profile the investor, before just recommending any product – be it conventional or mutual funds.

Following are the points an investor should ideally consider before investing in ELSS –

Are you a conservative investor?

If you are a conservative investor, you should avoid ELSS given its exposure to the equities, which by nature is volatile and risky. ELSS doesn’t need to remain positive at all times as it also goes through business and market cycle. Thus, investors who can’t withstand capital loss should stay away from such a product.

Are you investing for more than five years?

If your investing horizon is less than five years, you should ideally avoid ELSS. Given ELSS invests across the market spectrum, there may be some names that may not generate good returns in five year period, and you may need to remain invested for a longer period.

Following chart shows the wealth accumulation by investing in Aditya Birla Sun Life Tax Relief 96 plan.

Long-term investor

Source: Value Research

Short-term investor until lock-in period

Source: Value Research

As seen above, an investor who remained invested for long-term accumulated 5.4x wealth compared to the one who invested for three years and accumulated 1.07x. Please note we have assumed that an investor invested Rs 10000 per quarter.

Conclusion

To conclude, we can say investing in ELSS is an excellent way of accumulating wealth while saving tax. It is by far the best way of investment that is tax-free for any individual. Besides the superior returns and low lock-in period, the ELSS provides with the flexibility of SIP investment, comes with high transparency and is available instantly for investors. All these factors have made ELSS a must addition in one’s portfolio.

For all those who have not planned your taxes, you must conduct tax planning and take necessary decisions that shall enable you to save taxes. Also, planning will help you finalize your proofs before the HR manager knocks your door for the yearly investment proof. Tarrakki provides tax planning services for free to its customers. All you need to do is download the Tarrakki app available on iOS and Android both and advance to the tax savers option as shown below.

Should you need any assistance in your tax planning, or would want to speak your heart out, related to investments, to an expert, feel free to drop in a line. We are just a call/message/email away. Alternatively, you may connect with on social media as we believe in socializing after it’s all about your tarrakki.

Until next time, invest karo, tarrakki karo!

Pin It