ELSS Fund: Save Tax with Equity

What is ELSS Fund? Equity Linked Savings Scheme (ELSS), is a type of mutual fund.

There are two components to ELSS:

  1. Equity.
  2. Savings.

It has an equity component.

Means, the portfolio of ELSS Fund contains Equity.

What is Equity?


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“Equity share” of a company like TCS, RIL etc are commonly referred as Equity.

For a common man, Equity, Shares, Stocks are all different names of the same thing.

ELSS also has a saving component.

Yes, this is what differentiates ELSS from other mutual funds.

How ELSS is a “saving scheme”?

Because it allows its investors to save on income tax under section 80C.

If ELSS offers dual benefits, everyone investing in equity based funds must switch to ELSS, right?

The short conclusion is right. But ELSS has a limitation.

ELSS comes with a lock in period of 3 years.

#1. Why ELSS is unique?

Because it is only ELSS funds which gives dual benefits to its investors:

  1. Long Term : Capital Appreciation.
  2. Short Term: Income Tax Savings u/s 80C.

There is no other “equity based product” like ELSS in India.

[Note: ULIP is there, but I am not a fan of it] 🙂

Generally why we invest in equity?

For “higher returns” in “long term”.

What does it mean?

It means one must stay invested for “long term” to realise “high returns”.

This is perfect.

People who desire high returns, must invest in equity. But the only precondition is, to ensure long term holding.

In equity, one must not expect benefits in short term.

Hence people, whose goals are short term, invests elsewhere. In debt based plans. Not in equity.

What are short term goals? Example:

  • Income tax savings each year.
  • Vacation in Australia after 2 years.
  • Car purchase after 2 years.
  • Any goal which gets realized within next 3 years.

Which are debt based plans? Example:

  1. Life Insurance (Endowment Plan).
  2. Public Provident Fund (PPF).
  3. National Savings Certificate (NSC).
  4. Fixed Deposits (FDs) etc.

The point is, all investments are classified into two broad categories:

  1. Equity: serving long term goals.
  2. Debt: serving short term goals.

But Equity Linked Savings Scheme (ELSS) bridged this divide.

Here we can draw an inference that, ELSS funds has two roles:

  1. Role of a Equity Fund.
  2. Role of a Tax Saver Fund.

ELSS fund Save Tax with Equity

#2. Analysing “Equity Role” of ELSS Fund

It will be very interesting to know the portfolio composition of ELSS fund.

Let me share with you the portfolio composition of 5 biggest ELSS funds (in terms of their asset size).

What I mean by portfolio composition?

It means, what proportion of fund corpus is distributes in the following heads:

  • Equity.
  • Debt.
  • Money Market.
  • Cash etc.
SL Name AUM (Rs.Cr.) Equity % Debt % Money Market % Cash/ Call % Others %
1 Axis Long Term Equity 17,546 95.20 0.64 1.69 2.47 0.00
2 Reliance Tax Saver (ELSS) 9,545 99.01 0.00 0.61 -0.06 0.44
3 HDFC Tax Saver 6,654 90.01 0.04 0.00 9.95 0.00
4 SBI Magnum Tax Gain 6,268 97.91 0.00 1.73 0.00 0.36
5 ICICI Pru LT Equity (Tax Sav) 5,258 98.75 0.00 0.00 1.27 0.00
Average 9,054 96.18 0.14 0.81 2.73 0.16

The result of portfolio analysis of Top 5 ELSS funds is like this:

  1. 96.18% of ELSS’s corpus is invested in equity.
  2. 0.14% of ELSS’s corpus is invested in debt.
  3. 0.81% of ELSS’s corpus is invested in Money Market.
  4. 2.73% of ELSS’s corpus is kept liquid/in Cash.
  5. 0.16% of ELSS’s corpus is invested elsewhere.

What does this analysis prove?

It proves that ELSS fund is pure equity based investment vehicle.

#2.1 ELSS invests in which type of stocks?

It is also interesting to note that ELSS funds generally include which type of stocks in its portfolio.

What I mean by “type” of stocks?

  1. Large Cap,
  2. Mid Cap or,
  3. Small Cap.

Let me share with you a further detailed portfolio composition of following ELSS funds:

These are top 5 biggest ELSS funds (in terms of their asset size).

SL Name AUM (Rs.Cr.) Large Cap % Mid Cap % Small Cap %
1 Axis Long Term Equity 17,546 70 28.5 1.5
2 Reliance Tax Saver (ELSS) 9,545 52 33 15
3 HDFC Tax Saver 6,654 80 13 7
4 SBI Magnum Tax Gain 6,268 75 17 8
5 ICICI Pru LT Equity (Tax Sav) 5,258 72 24 4
Average 9,054 70 23 7

The result of portfolio analysis of Top 5 ELSS funds is like this:

  1. 70% of ELSS’s corpus is invested Large Cap Stocks.
  2. 23% of ELSS’s corpus is invested in Mid Cap Stocks.
  3. 7% of ELSS’s corpus is invested in Small Cap Stock.

What does this analysis prove?

The equity component of ELSS funds is reasonable diversified between variety of stocks.

Mid Cap and Small Cap stocks gives the following to the portfolio:

  1. Possibility of large returns in long term.
  2. High volatility in short term.

Large Cap stocks gives the following to the portfolio:

  1. Better price stability in short term.
  2. Average returns in long term.

Such a mix of stocks confirms that, in general, ELSS’s portfolio is a type of “diversified equity fund”.

#2.2 What Long Term Returns can be expected from ELSS?

Considering that ELSS is a type of diversified equity fund, its long term returns must be above average.

In India, average returns of equity could in range of 12% p.a.

Lets see the long term performance of following top 5 biggest ELSS fund (in terms of their asset size).

SL Name AUM (Rs.Cr.) 3Y-Returns 5Y-Returns 7Y-Returns 10Y-Returns
1 Axis Long Term Equity 17546 12.76 23.71 19.12
2 Reliance Tax Saver (ELSS) 9545 5.23 20.07 14.34 15.89
3 HDFC Tax Saver 6654 8.41 17.69 11.08 14.27
4 SBI Magnum Tax Gain 6268 5.65 16.15 12.32 11.9
5 ICICI Pru LT Equity (Tax Sav) 5258 10.37 19.79 14 15.32
Average 9054.2 8.484 19.482 14.172 14.345

The result of returns analysis of Top 5 ELSS funds is like this:

  1. 8.48% p.a. average return generated in last 3 years.
  2. 19.48% p.a. average return generated in last 5 years.
  3. 14.17% p.a. average return generated in last 7 years.
  4. 14.35% p.a. average return generated in last 10 years.

What does this analysis prove?

To obtain best results from ELSS fund, one must hold units of ELSS fund for a minimum of 5 years.

#3. Analysing “Tax Saver Role” of ELSS Fund

Where people generally park their money to claim income tax deductions under section 80C?

In debt based plans. Like:

  1. Life Insurance (Endowment Plan).
  2. Public Provident Fund (PPF).
  3. National Savings Certificate (NSC).
  4. Fixed Deposits (FDs) etc.

So if these traditional tax savings plans exist, why to opt for ELSS?

Because all above listed options are debt based plans. Hence they yield low returns.

ELSS is the only equity based investment options allowed under section 80C. Under Section 80C one can claim deduction upto Rs.1,50,000

[Note: ULIP is there, but I am not a fan of it] 🙂

As ELSS is a equity based plan, in long term it can yield much higher returns than debt based plans.

Let’s compare the returns of these traditional tax saving plans with ELSS:

SL Name Average Returns % Lock-in Period Returns is Taxable? Risk of Loss
A ELSS 14.17% 3 Years Partially Taxable High (not assured)
B.1 Life Insurance (Endowment Plan). 6% 10 Years No Low (assured)
B.2 Public Provident Fund (PPF). 7.60% 15 Years No Low (assured)
B.3 National Savings Certificate (NSC). 7.60% 5 Years Yes Low (assured)
B.4 Fixed Deposits (FDs) etc. 7.50% 5 Years Yes Low (assured)

What does this analysis prove?

Though ELSS fund is risky, but in long term they can yield much higher returns than debt plans.

How long must be long term in ELSS? Holding period must be more than 5 years.

The difference in potential returns between debt plans and ELSS is too wide.

It cannot be ignored.

  1. Debt Based Plans – 7.5% p.a.
  2. ELSS – 14% p.a.

#3.1 How much Income Tax can be saved by ELSS?

Lets understand this with an example.

A person whose net taxable income is say Rs.12.5 lakhs.

If he invests Rs.5,000 per month in ELSS, let’s see how much income tax he can save:

Without ELSS With ELSS (Rs.5000 per month)
Taxable Income (Rs.) 12,50,000 12,50,000
Deduction U/s 80C (ELSS)_Rs. 0 60,000
Net Taxable Income (Rs.) 12,50,000 11,90,000
Tax Payable (Rs.) 1,95,000 1,76,280
Annual Saving in Tax Paid 18,720

Final Words…

A person investing in ELSS fund can claim a maximum deduction of Rs.1,50,000 under section 80C.

For Equity investors:

Why Equity investors should consider ELSS?

They already invest in normal equity based diversified equity funds.

But these funds do not give them income tax relief.

ELSS fund can give them income tax relief.

Though ELSS funds are diversified equity funds, but it can also save tax.

The only compromise that an investor is asked to make here is, to agree for a lock-in period of 3 years.

I am sure equity investors will not mind it.

In equity based investment, anyhow people stay invested for much longer time horizons.

If one stay invested for 5 years or more, expected yield of ELSS fund can be 13%-14% p.a.

For risk averse investors:

ELSS funds can also be a nice investment option for risk averse investors.

On one side ELSS will provide short term benefits in form of tax savings year after year.

Hence, it will not be a lot of effort for people to stay invested for at least 3 years.

In a period of 3 years time horizon, expected yield of ELSS fund can be 7%-8.5% p.a.

Disclaimer: All blog posts of getmoneyrich.com are for information only. No blog posts should be considered as an investment advice or as a recommendation. The user must self-analyse all securities before investing in one.

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