ELSS – a tax saving instrument. Still?

Taxes | admin | February 24, 2011 at 6:00 am

The tax-saving season is upon us once again. A whole host of financial products are competing with one another to seek your attention. One such product that is vying for your attention – despite the rather poor performance of the stock market – is the equity-linked saving schemes (ELSS) from mutual funds. They are also known as tax-planning schemes. As the name suggests, these mutual funds schemes invest in stocks and they also qualify for tax deduction if you are ready to part with your money for three years.

Options under section 80C

However, thanks to the large number of products available under Section 80C, you need to weigh your options carefully before committing your money to a particular scheme. On the debt side, you have tax-saving instruments such as National Savings Certificate (NSC), Public Provident Fund (PPF), five-year bank fixed deposits.

All these products offer assured rates of return. However, these instruments have been offering negative real returns (or lower rates than inflation) for some time now and the situation may not change in the near term.

On the equity side, you have ELSS and unit-linked insurance plans (Ulips). “Ulips come with a high lock-in period of five years and higher charges, and hence mutual funds serve as a better option to invest in equities that generate inflation-beating returns at least costs,” says Trilok Mishra, a Mumbai-based financial planner. Three-year lock-in is another positive. Other options like NSC come with a six-year lock-in whereas Ulip blocks your money for five years. And PPF is a rather long 15-year haul.

You may also have to look at equity investment if you are looking for real returns in an inflationary scenario. Consider these factors: Inflation is on an uptick, food inflation is still high at 11.05%, and crude prices are soaring. Even the government has admitted that it is difficult to control inflation.

Due to the growth in emerging economies and reckless printing of currencies by most countries in the world, high inflation levels are expected to persist for some time. All these are strong reasons for investors to shop for real returns. In such a scenario, equities are a must. “Investment in equities through ELSS schemes can be a good bet to beat inflation in the longer term,” says Vishal Dhawan, founder, Plan Ahead Wealth Advisors.

A case for equities

In the short term, the stock markets in India have hit a roadblock. “There are too many headwinds bothering investors,” says Sadanand Shetty, V-P and senior fund manager, Taurus Mutual Fund. There are a series of scams right from the 2G, Commonwealth Games to others like the Adarsh Housing scam. Corporate governance is a constant worry for global investors. Inflation remained a cause of worry despite a tight monetary policy due to supply side issues. Then there are FIIs. As India kept the doors open for foreign flows throughout 2010, when other emerging markets closed their doors, it was a classic case of too much money chasing too few assets. No wonder Indian equities were overvalued compared to the growth prospects. India lost the ‘preferred destination tag’ for foreign institutional investors.

A possibility of increased input costs for most industries and rising inflation led to a correction in the domestic market. Further, higher interest rates and rising inflation could lead to lower corporate earnings in the coming year. On the global front, a recovery in developed markets like the US and countries in Europe is attracting FII money from emerging markets like India. It is for this reason that the Indian market has undergone correction. Investors increasingly feel that the fantastic returns that they reaped in 2009 and 2010 are a thing of the past. This has led to a huge correction in the markets since the start of the current calendar year. Several mid-cap and small-cap stocks have halved while large-cap stocks too have corrected in the range of 10-30%.

However, this has not changed the fundamental macro picture in India. Investing in equities gives you a chance to participate in the India growth story. “The Indian economy is expected to maintain its 8% growth rate, and with valuations at around 14 times FY12 earnings, it is a good time to invest with a three-year time frame,” adds Alok Ranjan, portfolio manager, Way2Wealth. Further, corporate profits are expected to grow in the region of 15-20% per annum, he adds. “Three years is a decent time frame for equities to perform,” says Shetty.

A peek into the past

According to Value Research, the 5-star rated ELSS funds have delivered 18.25%, 11.22% over one and three-year periods, respectively. Compare to this, S& P CNX Nifty delivered 9.62%, and 0.86%, over the same period, respectively. However, if you take the entire ELSS category into consideration, there is some underperformance especially, when compared to diversified equity funds.

“Some ELSS fund managers took aggressive calls on mid- and small-cap stocks, pulling down the average returns provided by this fund category,” says Abhinav Angirish, MD, InvestOnline.in. Though the category as a whole has not done well, there are some good schemes that investors can look at.

“If a scheme has not done well, after the mandatory lock-in period, investors could switch off and invest it in a diversified equity fund as part of their asset allocation”, says Anup Bhaiya, MD and CEO, Money Honey Financial Services.

How much to invest

“If investors are willing to take a five-to-ten year view, it makes a lot of sense to look at ELSS as there are options that have beaten the PPF by a comfortable margin, says Angirish. For the salaried class, besides the provident fund, the balance money to be invested under Section 80C should find its way into an ELSS, adds Dhawan. For professionals or business class, he advises investing at least 70% of the money into ELSS funds.

And, if you are an existing investor in ELSS and do not have enough money to invest ELSS and get tax shelter this year, consider this trick. Simply sell your existing ELSS investments and invest it back into the same scheme or a better ELSS scheme. This roundtrip does not cost you much. Since there is no entry load you do not lose as such. However, financial planners have a word of caution. “There is no harm in using this trick, as long as your tax plan is in sync with your overall financial plan,” says K Ramalingam, director and founder, Holistic Investment Planners.

If you invested in ELSS, assuming you will use that money 10 years down the line for your son’s education and flip it at the end of three years, it is fine. However, if you need the money for your son’s education five years down the line, then you should not flip the money, explains Ramalingam.

Source: Economic Times