Equities have always been associated with long term wealth creation. If you had invested Rs 1 lakh in S&P BSE Sensex at its inception in 1978, the investment would have been valued Rs 4.04 crore as of December 11, 2019, reflecting compounded annual growth rate (CAGR) of around 16% over the last 41 years. As such, it is always advisable to have a higher equity allocation towards long term financial goals. Such financial goals may include retirement planning, child education, and so on.
Further, to incentivise the taxpayers to invest in equities, Income Tax laws also provide for a tax deduction for making an investment in Equity Linked Savings Schemes (ELSS).
Such funds are specified equity-oriented funds, as notified under the scheme for a deduction equal to the amount so invested during the year, up to the ceiling limit as defined in Section 80C of the Income Tax Act, 1961, presently Rs 1.5 lakh. Such funds carry a lock-in period of three years from the date of investment and invest at least 65% in equities and equity-related securities. Since ELSS carries the lowest lock-in period amongst all the eligible investment options under Section 80C like Public Provident Fund (PPF), five-year fixed deposit, National Savings Certificates (NSCs), among others. ELSS carries the potential of becoming the preferred investment option amongst the taxpayers for tax savings and wealth creation.
The popularity of ELSS funds can also be gauged from the fact that 1.23 crore investor folios -- 20% of the aggregate equity folios -- have invested in ELSS funds with total Assets Under Management (AUM) of Rs 1.03 lakh crore as on November 30, 2019, according to Association of Mutual Funds in India - AMFI.
The investors can also register a Systematic Investment Plan (SIP) in ELSS funds and steadily move towards their tax planning and other financial goals. Further, with a mandatory lock-in period of three years, investors can resist the temptation of early redemption from the investment. As such, whether the markets are moving higher or lower, the investors in ELSS continue to stay invested, albeit due to compulsion of the lock-in period. Further, unlike other tax-saving investment options that are redeemed compulsorily at the end of investment tenor, the investors can opt to stay invested in ELSS post the expiry of the lock-in period. As such, the investors continue to remain on track to achieve their financial goals with ELSS investments.
This allows the fund manager to have a long term investment horizon, as the redemption pressures are lower due to the mandatory lock-in period of three years. This also reflects in the performance of the ELSS category of funds over the long term, which has even outperformed S&P BSE Sensex over the 10-year SIP investment period. ELSS funds, on average, generate 11.25% CAGR Returns over the last 10 years, as against 10.15% for S&P BSE Sensex over the same period (Data period December 1, 2009, to November 30, 2019, as per Bombay Stock Exchange).
Considering the mandatory lock-in period of three years, the returns from ELSS funds are always taxed as long term capital gains at a rate of 10% (plus applicable cess and surcharge). Further, the investors can claim tax exemption up to Rs 1 lakh per year for overall long term capital gains from equity shares and equity-oriented funds taken together, including the returns from ELSS redemptions.
With the potential of long term wealth creation and tax-efficient returns, ELSS funds can be considered for achieving long term financial goals effortlessly.
(The writer is the Executive Director & Chief Executive Officer of Reliance Nippon Life Asset Management Limited)