Comparison of ELSS Funds with Other Tax Saving Instruments

Tax saving is crucial to every individual’s financial planning, especially in India, where most people's tax-saving investment options can significantly reduce their taxable income in a financial year. These investments not only help save taxes but also help create wealth over time. The various tax-saving instruments available stand out as a popular investment choice.

Understanding how ELSS compares to other tax-saving options in section 80c, like PPF, NSC, Tax-saving Fixed Deposits, NPS, and SCSS, is mandatory for making an informed investment decision based on risk appetite and financial goals.

What Are ELSS Funds?

ELSS funds are a category of mutual funds with an 80% equity exposure that primarily invests in equities and is eligible for tax benefits under Section 80C of the Income Tax Act.

ELSS funds have a lock-in period of 3 years, the shortest among tax-saving instruments in section 80c. They allow investors to invest in equities while offering tax savings.

1)   Eligible for deductions under Section 80C, up to ₹1.5 lakh per year.

2)   ELSS are coming up with a mandatory lock-in of 3 years.

3)   The returns generated from ELSS funds are subject to market fluctuations, which means they can be higher than other fixed-income tax-saving instruments but with higher risk due to 80% equity exposure.

4)   After lock-in ends, investors can redeem 100% of units anytime, but the initial 3-year period restricts liquidity.

Historical Performance of ELSS

Historical data from the past decade shows that ELSS funds have provided an average return of 12-15% annually, making them one of the most attractive options for long-term tax-saving investors.

Other Tax Saving Instruments

Public Provident Fund (PPF):

PPF is a totally government-backed financial instrument, is totally low-risk, and offers tax-free returns to investors.

The PPF has a mandatory lock-in period of 15 years, after which partial withdrawal is allowed only after 6 years.

Investing in PPF can claim tax deductions of up to ₹1.5 lakh per annum under Section 80C in a financial year. Interest earned from PPF is 100% exempted from tax.

At Present, the interest rate for the PPF stands around 7.1% per annum.

National Savings Certificate (NSC):

NSC is a fixed-income instrument that offers a guaranteed return to investors.

NSC is coming up with a mandatory Lock-In Period of 5 years.

Tax deductions of up to ₹1.5 lakh under Section 80C are allowed in a financial year. Interest earned is taxable at the time of maturity.

The current interest in NSC stands at 7.7% per annum, which is compounded annually.

Tax-Saving Fixed Deposits (FD):

Tax-saving fixed deposits are a traditional investment product with a 5-year mandatory lock-in period. They qualify for tax deductions of 1,50,000 under Section 80C.

These fixed deposits are coming up with a mandatory lock-in, which cannot be withdrawn until 5 years from the date of investment.

They are eligible for tax deductions up to ₹1.5 lakh under Section 80C, where the Interest earned is taxable as per the investor's income tax slab.

The interest rates are fixed, and depending on the bank, they typically range between 6% and 7% per annum.

National Pension Scheme (NPS):

NPS is a retirement-focused investment scheme managed by the government.

These NPS have a huge lock-in period, which is until retirement (typically till the age of 60) for investors.

NPS offers tax deductions Up to ₹1.5 lakh under Section 80C and an additional ₹50,000 deduction under Section 80CCD(1B) in a financial year.

Historically, NPS has offered returns of around 8-10% per annum, depending on the asset allocation in TIER I AND TIER II.

Senior Citizens Savings Scheme (SCSS):

SCSS is a savings scheme, especially for senior citizens aged 60 or above, offering guaranteed returns.

These SCSS come with a lock-in period of 5 years, which is extendable to another 3 years.

SCSS are eligible for deductions up to ₹1.5 lakh under Section 80C. The interest earned from the SCSS is fully taxable at the investor's tax slab.

The current interest rate for the senior citizen savings scheme is around 8% per annum.

Comparison of ELSS vs Other Tax Saving Investments

This table compares ELSS funds and other tax-saving instruments across various factors.

Which ELSS or Other Tax-Saving Option which one is Right for You?

Risk-Averse Investors:

If you are a risk-averse investor who prefers guaranteed returns on your investments, lower-risk instruments like PPF, NSC, SCSS, and Tax-saving FDs will be more suitable for your risk appetite. These instruments are government-backed and provide safe returns, although they may not offer ELSS's high returns

If you are a risk-averse investor who prefers guaranteed returns on your investments, lower-risk instruments like PPF, NSC, SCSS, and Tax-saving FDs will be more suitable for your risk appetite. These instruments are government-backed and provide safe returns, although they may not offer ELSS's high returns.

Risk-Tolerant Investors:

ELSS funds are ideal if you are a risk-tolerant person willing to take on some market risk for potentially higher returns. The 3-year lock-in and long-term equity exposure make ELSS attractive for those who want to invest long-term and grow their wealth.

Long-Term Wealth Creation:

Due to its equity exposure, ELSS offers the best potential investment opportunities for wealth accumulation. It is the way to go if you have a long-term horizon and are looking for aggressive growth in your investment.

Balanced Investors:

If you are a balanced investor, you can go with ELSS and the PPF/FD portfolio, which can provide growth and security. This approach balances ELSS's high-risk, high-reward nature with the stability of fixed-income investments.

Conclusion

ELSS funds provide the highest potential returns among tax-saving instruments; they also carry higher risk due to their 80% equity exposure. On the other hand, instruments like PPF, NSC, and Tax-saving FDs are low-risk and provide guaranteed returns, but they may not match the growth potential of ELSS over the long run.

Assessing your risk tolerance, investment horizon, and financial goals before choosing the right tax-saving instrument is essential. A diversified approach that blends the best of both equity and fixed-income instruments could lead to an effective strategy to optimise your tax savings and financial growth over the long-term financial planning journey.