Published on March 5, 2014
GROWTH PLUS TAX SAVINGS WITH ELSS
GROWTH PLUS TAX SAVINGS WITH ELSS CONTENTS Introduction........................................................................................2 Beneﬁts of equity investing ..............................................................4 What is ELSS and how it helps ........................................................6 Invest with small amounts .................................................................8 The cost beneﬁt of ELSS .................................................................9 Options and lock-ins ....................................................................... 11 How to choose ELSS ...................................................................... 14 How many ELSS to choose............................................................16 How long to remain invested ......................................................... 17 Tax beneﬁts of ELSS .......................................................................18 How to start with ELSS investments .............................................18 Role of ELSS ....................................................................................19 Using ELSS for life goals ............................................................... 20 Common ELSS myths ....................................................................23 Project Editor Kundan Kishore Copy Editor Sutirtha Sanyal Art Director Manojit Datta Design Saji C.S. Cover Design Manojit Datta Copyright © Outlook Publishing (India) Private Limited, New Delhi. All Rights Reserved No part of this book may be reproduced, stored in a retrieval system or transmitted in any form or means electronic, mechanical, photocopying, recording or otherwise, without prior permission of Outlook Publishing (India) Private Limited. Printed and published by Maheshwer Peri on behalf of Outlook Publishing (India) Pvt. Ltd Editor: Udayan Ray. Published from Outlook Money, AB 5, 3rd Floor, Safdarjung Enclave, New Delhi-29 Outlook Money does not accept responsibility for any investment decision taken by readers on the basis of information provided herein. The objective is to keep readers better informed and help them decide for themselves. February 2013 [ 1]
GROWTH PLUS TA ELSS Sail the equity market with the benefit of tax saving and forced lock-in to meet your long-term goals W e work tirelessly through the year to make our life better for the present as well as the future, but strangely, when it comes to tax-saving, we wait till the last minute to decide where to invest and how much? And more often than not, we either end up investing in an instrument which gives low return or has a longer lock-in period. The other scenario is that of overloading our investment portfolio with the same asset class. As a matter of fact, most of us invest in tax-saving instruments just for the sake of saving on [ 2]
GROWTH PLUS TAX SAVINGS WITH ELSS AX SAVINGS WITH our taxes. If we invest in tax-saving instruments with proper planning, not only will our investments fetch us a good return, but also help us achieve our major ﬁnancial goals such as one’s own marriage, children’s needs, owning a home and retirement. However, the choice hinges on our risk appetite, tax bracket and whether there is a need for regular income. Equity-linked savings scheme (ELSS) can be the product for you given its threeAN INVESTOR EDUCATION AND AWARENESS INITIATIVE BY HDFC MUTUAL FUND [ 3]
year lock-in period and returns linked to the equity market. BENEFITS OF EQUITY INVESTING We all want to enjoy our life. While some want to enjoy it with family and friends, others want to retreat to some quiet place. But what most of us fail to consider is that fulﬁllment of any vision requires careful planning and, that too, right from the start. And it is here that investment in right instruments come into play, for they can fetch you better returns. As an asset class, equity can provide high returns, but they also come with their fair share of risks. The challenge lies in understanding the behaviour of equity markets over a long period of time—not a year or three years, but over a decade or even more. Despite some volatility, equity has delivered the best return in the long run. In the last 10 years, the average return from equity funds has been quite impressive. So, if you are investing for your long-term ﬁnancial goals, then you must have equity in your portfolio. But in the short run, it’s a risky asset class. As we have seen in the last few years, stockmarket volatility could lead to capital erosion from your equity investment. Also, in order to create wealth over the long term, one needs to put savings into assets that can deliver higher than inﬂation returns. Else, inﬂation will eat into the returns and won’t help you in accumulating a corpus. Whatever be your [ 4]
GROWTH PLUS TAX SAVINGS WITH ELSS risk proﬁle or the quantum of savings, it’s imperative to use equity-backed investment products to nullify the effect of inﬂation, especially over the long term. The veracity of using equity to meet long-term goals have been proven time and again. Studies done in the past have shown that equity has delivered higher inﬂation-adjusted return than any other asset class over the longer horizon. The underlying message here is the time horizon; the longer one remains invested in equities, the better is the return. The advantage comes from AN INVESTOR EDUCATION AND AWARENESS INITIATIVE BY HDFC MUTUAL FUND [ 5]
the power of compounding because the earlier you start investing, the more time your money gets to grow. If you start saving early, even in small amounts, it will help you build a sizeable savings portfolio. The rule is to invest regularly and keep reinvesting the returns so that your earnings also help in fetching more returns. A ﬁrst-time investor in equities should ideally start with equity mutual funds (MFs). Jumping into the stockmarkets with little or no knowhow may not be the right thing to do. An early start to investing with equity MFs also inculcates a disciplined habit of investing. Stockmarkets remain volatile in the short-to-medium term but average out over the longer horizon. An investor having seen the ups and down of such market remains poised for the long haul and is largely undisturbed with such frequent ﬂuctuations. And most importantly, mistakes made during the initial days of investing helps one learn the basics of investment that come to one’s aid in the later stages of life. That said, one can even take to equity investing with ELSS. They offer market-linked return and have a shorter lock-in period and also offer a cost-effective way for the small investor to access equity markets. WHAT IS ELSS AND HOW IT HELPS? Equity Linked Savings Scheme (ELSS) launched by mutual funds are open-ended schemes having a lock-in period of three [ 6]
GROWTH PLUS TAX SAVINGS WITH ELSS years (with no assured returns) and are formulated as per the notiﬁcation dated 28 December 1992 as amended on 22 December 1998 and the notiﬁcation dated 3 November 2005 as amended on 13 December 2005 issued by the Department of Economic Affairs, Ministry of Finance, Government of India. Further, the Ministry of Finance vide its press release dated 11 November 2005 stated that the Central Board of Direct Taxes (CBDT) has clariﬁed that investment made on or after 1 April 2005 in the schemes which are in accordance with ELSS 1992 or ELSS 1992 as amended in 1998 are also eligible for tax beneﬁt under Section 80C of the Income tax Act, 1961. Investment in ELSS helps one in planning one’s taxes, thereby reducing the tax burden. ELSS investments reduce the taxable income corresponding to the amount invested and, thereby reduces the tax liability of the investor under Section AN INVESTOR EDUCATION AND AWARENESS INITIATIVE BY HDFC MUTUAL FUND [ 7]
80C. As the name suggests, ELSS is a savings scheme that is linked to equity. Investment avenues for your savings can be a mix of various asset classes such as equity, debt, gold, real estate and so on. An ELSS is an MF scheme, which is similar to any diversiﬁed equity MF scheme that routes your investments into the equity markets. Like any other MF scheme, an ELSS is also managed by professionals known as fund mangers. This helps small investors in accessing the equity market and also save taxes at a reasonable cost. INVESTMENT WITH SMALLER AMOUNT ELSS allows the investor to buy units under a scheme with a minimum investible amount of `500 and in multiples of `500 thereafter. Investments can either be in lump sum or [ 8]
GROWTH PLUS TAX SAVINGS WITH ELSS through the system investment plan (SIP) route. But, considering the volatility in the stockmarkets, it is better to invest in ELSS through the SIP route. You get to make your investments in the equity markets with a smaller amount and because the investment is in an ELSS, you also save taxes. As such one cannot deﬁne the right time to invest in equity MF scheme or ELSS through SIP. There is no maximum investment cap, but the tax advantage in ELSS is only up to `1 lakh. ELSS is part of the Section 80C instruments which are cumulatively eligible for a deduction from income up to `1 lakh. THE COST FACTOR Every investment has a cost attached to it. However, after the capital markets regulator, the Securities and Exchange Board of India (Sebi) abolished the entry load on all MF schemes in 2009, one doesn’t have to pay any upfront load on one’s investment. That said, there is still a transaction charge on your investment if you are a ﬁrst time mutual fund investor and wish to invest through a broker. This could be up to `150 if your investment amount is `10,000 in a year. But if you invest directly with the fund houses, there is no charge on your investment. Still, you will have to bear an indirect cost known as recurring expenses on your investment. In simple terms, the net asset value (NAV) declared by the funds are adjusted and reduced by this percentage on a regular basis. Theoretically, the recurring expenses chargeable could be up to 3 per AN INVESTOR EDUCATION AND AWARENESS INITIATIVE BY HDFC MUTUAL FUND [ 9]
cent per annum of the average assets of the scheme. However, in practice, such expenses would rarely exceed 2.50 per cent. This is because of competition and regulations that require such charges to be on a sliding scale and is based on factors such as average assets. Recurring expense includes expenses incurred on the investment management and advisory fees, expenses towards brokerage, registrar, marketing, fees of custodian, auditors, trustees and certain other expenses as well. As per directives from Sebi, mutual funds have introduced Direct Plan for investors who purchase or subscribe units in a scheme directly (i.e., not routed through a distributor) effective 1 January 2013. Direct Plan shall have a lower expense ratio excluding distribution expenses, commission, etc. [ 10]
GROWTH PLUS TAX SAVINGS WITH ELSS Also, no commission for distribution of units will be paid or charged under Direct Plan. ALL ABOUT ELSS—OPTIONS, LOCK-INS Options. The ELSS funds available may either be the on-going funds which declare their NAVs on a regular basis, or the new ones, called the new fund offer (NFO), which are in the process of mobilising funds from investors and will declare their NAV in future. As an investor, you can either choose the growth or the dividend option. Some funds also have the dividend re-investment facility. For making an ELSS investment, you ﬁrst have to decide on the mode of investment, either lump sum or through SIP and then choose the growth or the dividend option. A growth option allows capital appreciation due to the compounding nature of the investment while the dividend payout option provides liquidity. To some investors, this is a good option as an ELSS has a mandatory three-year lock-in period. The dividend from the ELSS investment can be invested in other investment options, either equity or debt, depending upon the rebalancing needs of the investor’s portfolio and, thereby, reduce the risk in the overall investment plan. From the tax perspective, both the dividend and the growth options are equally efﬁcient as the dividends are tax-free. As far as dividend reinvestment goes, investors should avoid it. One cannot change the investment option midway in a fund with AN INVESTOR EDUCATION AND AWARENESS INITIATIVE BY HDFC MUTUAL FUND [ 11]
a lock-in period. Thus, if you were to choose the dividend reinvestment option, there will be incremental lock-in of three years on the dividend reinvested and no tax deduction can be claimed on such re-invested dividend. At present, all ELSS available are open-ended and so, provide the ﬂexibility to invest or withdraw (subject to the completion of lock-in period) at any time during the year, without being restricted to any speciﬁed time period. In effect, this helps the investor manage his/her cash ﬂow better. The funds that become open-ended three years into their purchase by an investor allow the investor to continue with his or her investment and redeem it as per the market condition. However, in the event of death of the unitholder, the legal heir, subject to production of the requisite documentary evidence, will be able to redeem the investment only after the completion of one year or any time thereafter, from the date of allotment of units to the deceased unit holder. Lock-in. Investments in an ELSS have a lock-in period of three years and there is no option to exit early. The lock-in prevents early withdrawal of your investment and helps your money grow over a period of time. Experts have always advocated a long-term view for investment in equities. The lock-in sees to it that you ignore short-term market ﬂuctuations and remain focused on creating wealth in the longer-term. Besides, when compared to other tax-saving instruments, such [ 12]
GROWTH PLUS TAX SAVINGS WITH ELSS as the National Savings Certiﬁcate (NSC) and Public Provident Fund (PPF), which have lock-ins of six and 15 years, respectively, a three-year exit restriction is on the shorter side. The lock-in also lends an element of stability to ELSS portfolios. Since corporate money is kept out, these schemes don’t have to deal with sudden, large-scale redemptions. As a result, ELSS tends to have a more stable corpus and an optimum corpus size, which encourages better fund management. Due to this lock-in-period, the Asset under Management (AUM) remains more stable and the cash ﬂow is more predictable and also leaves fund managers with less burden of managing redemption. This provides the fund manager with greater freedom to perform. The fund manager can take a medium- tolong-term view on certain stocks; this helps in improving the returns from the schemes. The lock-in-period of three years in AN INVESTOR EDUCATION AND AWARENESS INITIATIVE BY HDFC MUTUAL FUND [ 13]
ELSS also allows the investor to become more disciplined and realise the true potential of the investment made. The asset allocation is as per the ELSS guidelines. The funds are typically invested in equities, cumulative convertible preference shares and fully convertible debentures and bonds of companies in the 80-100 per cent range and up to 20 per cent for debt and money market instruments. The asset allocation in itself speaks for the big tilt towards the equity market. Therefore, ELSS is well-poised to deliver better returns. Liquidity. The units of ELSS plans have a lock-in of three years from the date of their allotment. These units can be redeemed i.e., sold back to the fund house on every business day, at the redemption price, three years after their allotment. HOW TO CHOOSE ELSS SCHEME- MARKET CAPS, SCHEME OBJECTIVES, PERFORMANCE Before selecting an ELSS, ensure that your investment takes into account your risk proﬁle and the overall asset allocation of your portfolio. Remember that higher returns from ELSS come with higher-risk, for the simple reason that the investments are market-linked. These schemes are suitable for investors willing to take higher risk for better returns from their tax-saving investments. Choose funds with a longer performance history and trackrecord for investments. The longer the performance history, [ 14]
GROWTH PLUS TAX SAVINGS WITH ELSS the longer time a fund has to test its mettle in various market situations. That would also make it easier for the investor to evaluate consistency in a fund’s performance. The performance of the fund should be compared with that of its benchmark and peers. An investor should also assess the risk and return strategy of the fund and take a call on whether he is comfortable with it. Fund houses with strong and established processes and the ones that focus on fund management teams rather than star fund managers are better. The focus of the fund’s portfolio to different segments of the market, such as large-, mid- and small-cap, gives an indication of the volatility that an investor can expect in a fund. However, majority of the ELSS are inclined towards large-cap AN INVESTOR EDUCATION AND AWARENESS INITIATIVE BY HDFC MUTUAL FUND [ 15]
stocks as far as portfolio building is concerned. Also the threeyear lock-in reduces the risk in equity investing to a great extent and allows the fund manager to choose stocks with longterm potential without liquidity concerns. One should also look at the type of fund management style ELSS funds carry and whether they invest in value or growth stocks. The biggest advantage of an ELSS is that it allows investors to choose products according to their risk appetite. The suitability of a fund depends upon the compatibility of the fund’s strategy with the risk appetite of the investor. HOW MANY ELSS SCHEMES SHOULD ONE HAVE? There is no ﬁxed rule to this. Around 2-3 schemes can be a part of your portfolio depending on your investment amount. [ 16]
GROWTH PLUS TAX SAVINGS WITH ELSS It helps you diversify across different fund managers too. Too much of them could be a deterrent as well. Managing them and tracking them will be difﬁcult. Besides, there could be overlaps in the stocks they hold, thus reducing the advantage of a concentrated portfolio. Have a look at their individuals portfolios to determine the mid-cap or the large-cap focus of the funds and then take a decision. HOW LONG TO REMAIN INVESTED IN ELSS Ideally, there is no maximum limit on the time horizon you can remain invested with the fund. However, once the threeyear lock-in period is over, you need to closely monitor the scheme’s performance. If it is at par with other open-ended equity schemes, you can remain invested with the scheme. But if the scheme is lagging on performance, you can switch to better performing equity saving schemes. Also, if your existing investment has completed three years and you have to invest again for the current year, you may like to reinvest the corpus in the same scheme to get the tax beneﬁt of the current year without having to make any additional investment provided the scheme performance is at par with its peers. If your ELSS investment made in the past is about to mature in the next 3-6 months, you need to decide carefully. Once you complete three years in an ELSS, review your investment. After all, one of your objectives (the tax deduction) has been met. Tax laws don’t allow a rollover for claiming beneﬁt under AN INVESTOR EDUCATION AND AWARENESS INITIATIVE BY HDFC MUTUAL FUND [ 17]
Section 80C. They insist on fresh investments. So, evaluate your “matured” ELSS investment as a normal equity investment and base your decision to stay on or exit on your perception of the market and the need for funds. You could either liquidate all or partial units. But if you don’t require funds urgently, postpone liquidation to few more months. ELSS TAX BENEFITS— INCLUDING FOR SIP MODE Lump sum or in instalments. You may either invest in lump sum or choose the SIP mode. Identifying the scheme and starting a SIP would ensure that the investor beneﬁts from lower acquisition costs through rupee cost averaging in a volatile stockmarket. Investing periodically also spreads the burden. However, remember that each instalment will be subject to a three-year lock-in. So, if you enroll in a three-year SIP and invest systematically every month for three years, you will get your entire proceeds only after six years (after your last instalment at the end of the third year completes three years). HOW TO GET STARTED WITH ELSS When you start working, the savings for tax-saving investments could typically be your entire savings, as the expenses are pretty high at this stage of your life. Like the rest of your working life, during this period too, your provident fund savings will by default take up some portion of the total deduc- [ 18]
GROWTH PLUS TAX SAVINGS WITH ELSS tion under Section 80C of the Income Tax Act, 1961. During this stage of your life, since you are likely to be without major responsibilities or liabilities, you can take risks with your investment such as those involved in equity MFs. This is why many ﬁnancial experts recommend investing in ELSS of MFs. With ELSS, you can invest even amounts as less as `500 every month in equity MFs through SIPs. ROLE OF ELSS IN INVESTMENT PORTFOLIO As discussed earlier, it’s best not to own more than 2-3 ELSS in one’s portfolio. Also, ELSS should be treated as part of the overall portfolio and not merely as a tax-saving instrument. By keeping a few strategies in mind, an investor can make the AN INVESTOR EDUCATION AND AWARENESS INITIATIVE BY HDFC MUTUAL FUND [ 19]
most of his or her investment. Keeping financial goals in mind. Every ELSS adopts different stock picking strategies. Some schemes maintain a largecap focus and are suitable for investors who have a lower risk proﬁle. On the other hand, funds that have greater exposure to small- and mid-cap stocks ﬁt the portfolio of an investor willing to take a higher degree of risk. Ignoring this aspect could lead to a mismatch between the fund and the investor’s proﬁle. Diversify among styles. The role of ELSS in a portfolio is restricted to providing tax beneﬁts without compromising on the return. It cannot form the core of your MF portfolio. A portfolio should at most stick to two ELSS with varying investment styles in the market if one wishes to diversity. USING ELSS FOR LIFE GOALS—MARRIAGE, CHILD’S FUTURE, HOME BUYING & RETIREMENT Investors can use ELSS investment to fulﬁl their life goals, such as their children’s future, retirement planning and home buying. The only thing one needs to do is link his or her goals with the time horizon left for each speciﬁc goal. As a rule of thumb, an investor should focus on the tenure left for each goal rather than his or her risk proﬁle. For instance if one is married, his or her income would have gone up further and so would have their Employees Provident Fund (EPF) deduction. This would leave the investor with lesser elbow room for making invest- [ 20]
GROWTH PLUS TAX SAVINGS WITH ELSS ments under Section 80C of the Income Tax Act, 1961. If possible, one should increase them to exhaust the Section 80C limit. In case of a double income households, one should ensure that most of the tax-saving investments is from the income in the higher tax slab. If both the incomes are in the highest tax slab, the risk-taking capability is higher. This means that such working couple should invest more in ELSS, besides both of them investing in PPF. This corpus can either be utilised for funding the retirement expenses or for the children’s future. Also, a child’s education, his or her wedding, buying a house, or retirement require planning as these are long-term goals. As such, they will require disciplined investing on your part. Besides, you should also ignore booking proﬁts for the short-term or else you could end up losing on the compounding effect on your long-term investments. It is here that the lock-in associated with ELSS comes handy and prevents the investor from booking proﬁt for the short-term. Even a person nearing retirement or one who has already retired, may invest in ELSS, if he or she has an appetite to take AN INVESTOR EDUCATION AND AWARENESS INITIATIVE BY HDFC MUTUAL FUND [ 21]
slightly higher risk to get better return. As one nears retirement, one typically likes to invest in options that don’t have lock-ins. It is better to keep investing in existing investments such as PPF and better still, to increase the contribution to ones EPF since one will be getting the money shortly and, also to give further impetus to the compounding effect. As such, plan your investments in ELSS keeping in consideration the year you will be retiring. Remember that you need to remain invested in equity even in your retirement years to take care of inﬂation. When you are retired, your obligations under Section 80C might not be much. In addition to ﬁxed income tax savers such as Senior Citizens Savings Scheme (SCSS) and others, if you need to save taxes, you may still look at ELSS. The key is to ensure that not all of your investments are in ﬁxed income investments since they won’t help you combat inﬂation. The two facets that makes the ELSS plans stands apart from a normal diversiﬁed equity plan is the tax-saving feature and their link with the equity market and, because they are equity-linked, always remember that there is a certain amount of risk involved: equity schemes are not for the weak-hearted. Ultimately, you are the best judge of where to invest and what suits your portfolio best. Let us leave you with one last thought. If you are planning to invest lump sum in ELSS don’t [ 22]
GROWTH PLUS TAX SAVINGS WITH ELSS wait till the last minute. Whenever the stockmarket falls by 5-10 per cent, invest some part of it during every correction to capitalise on the potential uptrend. However, it is better to invest using a systematic investment plan (SIP) that reduces the average cost of your holding in a volatile market. COMMON MYTHS TO AVOID There are some common myths always associated with ELSS investments. That needs to be avoided. Some of the common myths are that low NAV funds are cheaper, dividend declaration in next week or so on, short-term investments, etc. These three are the most common tricks MF distributors use to lure AN INVESTOR EDUCATION AND AWARENESS INITIATIVE BY HDFC MUTUAL FUND [ 23]
investors. However, this does not hold true. Buying last year’s top performer is the only criteria that many investors use to select a scheme for inclusion into their portfolio. The conditions that made a fund an outperformer during a particular period may not exist in the subsequent years. A fund’s performance should be tested for consistency across time periods and then selected if it matches the investor’s need proﬁle. So while investing in ELSS, you should look at long-term performance track record of the scheme, say 3-5 years rather than their short-term performance or lower NAV. Also, if you are looking for dividend options, a dividend declaration any time soon should not be the only criteria. There could be a possibility that a good performing fund might not be declaring dividend soon at the time of your investment. However, in the future, it may declare dividend and also reward you handsomely in the long-run in terms of its performance. AN INVESTOR EDUCATION AND AWARENESS INITIATIVE BY HDFC MUTUAL FUND
GROWTH PLUS TAX SAVINGS WITH ELSS
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