Article: How ELSS scores over other tax saving avenues

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Fact

Under Indian tax laws, savers have a complete range of tax-saving instruments like Public Provident Fund (PPF), Tax-saving fixed deposits (FDs), National Savings Certificate (NSC), Equity-linked Saving Scheme (ELSS) and others

Question

Yet, individuals often take sub-optimal investment decisions with their tax-saving investments. Why does this happen?

Answer

There is a confusion of goals between saving tax and making investments.

Equity Options

There are two options other than ELSS that give equity-linked returns - Unit-Linked Insurance Plans (ULIPs) and the National Pension System (NPS)

ULIPs

Longer lock-in period of 5 years, coupled with high costs and poor transparency.

Traps:

1. Mix of investment + insurance 
2. Savers don't have clear cost-vs-benefit understanding of either 
3. Both transparency and liquidity relinquished
4. Terminating the policy early affects returns adversely (instead of 5-year lock-in, it becomes a 10-15-year commitment)

ULIPs aren't suitable for investment due to:

1. High costs
2. Difficulty in evaluation
3. Lack of transparency
4. Low liquidity

NPS

Retirement solution rather than a savings one. It has only partial exposure to equity and a very long lock-in period that effectively extends till retirement age.

ELSS

3-year lock-in period

Short-term vs long-term: 

1. Equity investment carry higher risk over the short-term. 
2. However, for investment periods of five years or more, the risk on equity investments is considerably lower. 
3. When you take inflation into account, bank FDs and similar deposits turn out to be sub-optimal because of inflation.

The best way of investing in an ELSS is through monthly SIPs (Systematic Investment Plan) throughout the year. SIPs also give the dual advantage of avoiding any last-minute rush.

 

At the beginning of every year, estimate the amount you have leftover from the Rs 1.5 lakh limit after statutory deductions, divide it by 12 and start an SIP. 

Simple.