Equity Linked Saving Scheme (ELSS)

Equity linked saving schemes are a kind of mutual funds like diversified equity funds with
Tax benefits. It is just like other tax saving instruments like National Savings Certificate and
Public Provident Fund. Main advantage with ELSS is lock-in period is only 3 years while for
NSC it is 6 years and for PPF it is 15 years. At the same time risk factor is high in ELSS.

As per Income Tax act 80c investment up to Rs 1,00,000 are eligible for deduction from the
gross total income hence reducing the total taxable income. For example if your total annual
income is Rs 3,00,000 and you invest Rs 1,00,000 in ELSS then your taxable income will
become Rs 2,00,000.

Previously there was an upper limit for investing in tax saving instruments like ELSS of
5,00,000. Only individuals with less than 5,00,000 annual income are allowed to invest in
tax saving instruments. But last year financial budget removed this restriction and now any
individual can invest in ELSS irrespective of their income level.

Disadvantages of ELSS

1. Risk factor is high compared to NSC and PPF

2. Premature withdrawal is not allowed but it is allowed in other instruments in some
specific conditions.

Diversified Equity Schemes and ELSS

Both Equity linked saving scheme and diversified equity scheme operates in same way. Both
are high return and high risk schemes. But there is a 3 year lock in period of ELSS and it
provides tax benefits too.

Systematic Investment Plan

Best way to invest in ELSS is through Systematic Investment Plan(SIP). With SIP you can
invest a small amount every month for a specific time period. With SIP investor can take
advantage of fluctuations in the stock market. So investor will get more units when the
market is down and get less units when the market is up. For eg if you are investing Rs
1000 every month and you will get 100 units for when Net Asset Value (NAV) is 10 and will
get 50 units when NAV is 20. So investing a fixed sum regularly helps to cover the market
fluctuations by rupee costs averaging. Also most of the Asset Management Companies
(AMC) charges less entry load for SIP compared to normal purchase.
Some advantages of ELSS are
* The 3 year lock in period prevents withdrawals and thus allows your money to
grow over a period of time. Long term investment in equities gives better returns
than any other investment instrument.

* It gives tax benefits (Up to 30% for people in the highest tax slab)

* Gives the flexibility to invest small amounts through a Systematic Investment

Plan (SIP)

As an ELSS investor, your interests will be safeguarded by two separate market

bodies. The Association of Mutual Funds in India (AMFI) and the Securities and
Exchange Board of India (SEBI)
Let me explain the returns on an ELSS with an example:
Lets assume you invest Rs. 1 lakh this year in an ELSS scheme and you are in the
highest tax bracket.

Some ELSS schemes also offer personal accident death cover insurance

Provides 30 to 40% returns compared to 8% in NSC and PPF

Invested Amount = Rs. 1,00,000/-
Income Tax saved = Rs. 30,000 (30% tax slab)
Net amount Invested = Rs. 70,000/- (I have deducted the 30,000 because you get
it back up front after your investment as income tax benefit and you effectively
invested only Rs. 70,000)
Let us assume your equity investment grows at the rate of 15% per annum.
Investment value at the end of the First year = 1,15,000/-
Investment value at the end of the Second year = 1,32,250/-
Investment value at the end of the Third year = 1,52,087/-
Assuming you encashed your investment at the end of the 3rd year you will get Rs.
1,52,087/-
Profit you realized = Rs. 82,087/- (You invested only Rs. 70000 effectively
remember the tax saved)
Profit percentage = 117% (For 3 years together)
Returns % per year = 39%
A Returns of 39% per annum is something we cannot expect in any other form of
investment. Thus ELSS schemes make one of the best investment options.

How is your ELSS Money Invested?

This is a very common question that people have. The asset allocation is pre-
determined and is in accordance with SEBI guidelines. Between 60% to 100% is
invested in equities, cumulative convertible preference shares and fully convertible
debuntures and bonds of companies. Money market instruments account for
anything between 0% to 20% The asset allocation shows a tilt towards equities
which has the scope for providing good returns for us. The choice of industries and
allocation to mid-cap and large-cap companies depends on the individual scheme &
its fund manager. As an investor, we must first understand the objectives of the
fund and also go through the offer document before investing.

Difference between an ELSS fund and a Equity Diversified Mutual Fund

Both ELSS and Diversified equity schemes have the same risk profile. Both are high
risk – high return investment avenues. The major difference lies in the fact that an
ELSS scheme has a lock in period if 3 years and a diversified equity scheme comes
with no such conditions.
It is always advisable that Equity investments be made for the long term to help
the fund outperform other asset classes. The lock in period for ELSS supports this
view and also allows the fund managers to plan a strategy that would be beneficial
in the long term. On the face of it, the 3 year lock in stipulation might be a
deterrent to investors, but it has its own advantages.
* By forcing us to wait 3 years, it makes us take a long term view of the market,
which induces investing discipline to a certain extent
* The real potential for returns from equities can be realized only if we stay
invested for at least a few years
* The fund manager knows that the investment would not be encashed in the next
3 years and hence they can plan and devise a strategy that can help us benefit. The
manager can choose the sector and stock bets with freedom that he does not get in
regular equity schemes
The performance of an ELSS and a diversified fund may also vary.
The difference in performance usually arises from the differences in managing
styles and the market rewards for a particular style at a given time. ELSS schemes
may have a small & mid cap bias. Fund managers may like to take advantage of the
lock in period to exploit value stories in these sectors. Many diversified equity funds
tend to have a large cap and growth bias. Therefore, during periods when growth
stocks and large caps dominate, diversified equity funds would outperform ELSS
Schemes.
But if we calculate the returns of ELSS schemes including the tax benefits we get
out of it, they would outperform the diversified equity class.