Bad News for ELSS Investors

The Indian Income Tax policies as per the budget this year has had its share of good as well as bad news. While everyone expected a significant hike in tax slabs and section 80C, the reality was far from what was expected. To know more about the Indian Income Tax policies click here

Though there wasn't much change in these areas, there was however one significant news. This news affects all Mutual Fund Investors who invest in ELSS Mutual Funds to reap the benefits offered under Section 80C. The purpose of this article is to elaborate on that new policy and to analyze how it affects us.

So, lets get started!!!

What is ELSS?

Well, this is something we have covered in various articles in my blog in the past. ELSS stands for Equity Linked Saving Scheme and is a variety of Mutual Fund that invests in the stock market as well as provides tax benefits to investors under the section 80C of the Indian income tax policies. To know more about ELSS you can refer to the below articles:

What is ELSS

Saving Tax through Investments

Now that we have covered the basics, lets get down to business.

What is the current state of ELSS in India?

Until now, Equity Linked Service Scheme (ELSS) has been one of the first-choice mutual funds for Indian investors. As you might have read in the article on what is ELSS, It has two main benefits:
1. It helps you to save tax and
2. It helps you to invest in the stock market.

The 3 year lock-in period ensures that the investment is long-term and also is protected from market fluctuations. Market Statistics reveal that Rs 23,700 crores worth of ELSS schemes have been invested in May 2010 as compared to Rs 11,800 crores in May 2007. Between 60-120 lakh people regard ELSS as a tax-saving investment and are invested in the various ELSS schemes available in India.

What is DTC?

DTC stands for Direct Tax Code. It determines what income in India is taxable and the kind of taxes individuals who earn an income in India have to pay.

Impact of DTC 2011 on ELSS Investments

The DTC code 2011 has significantly affected ELSS Investments in India. This is because:

Starting April 1, 2012, no new ELSS Mutual Funds will be exempted from taxes taking away one of the biggest motivators of ELSS Investment. This is likely to hit the investors as well as the Mutual Funds industry hard.

How does this affect us?

Well, this is really bad news because – Starting April 1st 2012, all fresh investments into ELSS schemes will no longer be eligible for tax benefits. Which essentially means that ELSS mutual funds are no longer an option for tax saving.

I personally feel that the best option to save tax for the younger generation has been taken away from Investors.

Is it sensible to still invest in ELSS?

The important point to be noted here is that according to the revised 2011 Direct Tax Code, only ELSS Mutual Funds initiated after April 1, 2012 will not be exempted from tax deductions. This does not apply to already existing ELSS funds and investments made before the aforementioned date, so it would be to wise to avail this offer while it is still available. So, you can still invest in ELSS mutual funds for this financial year 2011 – 2012 and reap the benefits they offer before the validity period runs out…

What will happen to the ELSS Funds Starting April 2012?

They will become regular Equity Mutual Funds. They will still continue to operate as regular equity oriented mutual funds that investors can invest in, with two major differences:

1. There will be no tax benefits on investing in ELSS funds &
2. There will be no 3 year lock-in period.

To sum it all up in one word – ELSS schemes will no longer be a separate class of Mutual Funds and would become regular Equity Oriented Mutual Funds.

What has happened because of this new DTC Ruling?

Despite the fact that tax benefits for ELSS funds already in existence will continue, there has been a rush among investors to exit these schemes. ELSS was considered a sort of starting point for budding investors as they made their entry into the equity market, but with the coming of the DTC this looks certain to change. From next year onwards, there are no tax benefits for investing in these schemes and hence they will become less and less favourable for investors and people will start exiting them, big time. So, the NAVs of your funds might drop significantly.

What should we do now?

Below are some options that are available for us. They are based on your situation:

1. If you are a seasoned ELSS Investor (Someone like me who started investing in ELSS schemes years ago) and your investments are past the 3 year lock-in period then:

a. Check the performance of the fund in the past one year and if their performance is not at par with the best performing Equity Diversified Mutual Funds – Exit them and invest in a well performing regular Equity Diversified Mutual Fund Scheme
b. If your fund is performing very well, keep your fingers crossed and review the funds performance once every 2-3 months and exit the scheme at the point where you feel the fund isn’t performing as well as it is supposed to be.

2. If you have just started investing in ELSS Schemes in the past one or two years:

a. Wait till your investments complete the mandatory 3 year lock-in period. Once it completes 3 years, check out your options as mentioned in point 1 of this section and exit the funds, the moment you feel the fund NAV is falling significantly.

3. If you are a new Investor considering ELSS as an investment option:

a. You have only one year to take advantage of the tax benefits
b. So, invest in the best ELSS mutual funds available in the market and keep your exposure limited
c. Do Not Invest in newer or smaller ELSS MFs that aren’t performing as well as their experienced cousins

Is it the End of the Road for ELSS Schemes?

Well, to be honest, the answer is Most Probably Yes. There might be no fresh investments into ELSS schemes and hence, they might run out of business in the next 4-5 years. So, personally I would suggest you check out other investment options for tax saving and regular Equity Diversified Schemes for Mutual Fund Investments.

But, and this is a big BUT, a point to remember is that, this DTC is just a draft bill and is yet to be passed as a law. If in the next one year (before April 1 2012) the bill doesn't become a Law, ELSS funds might continue to provide tax benefits to Indian investors.

So, lets keep our fingers crossed and hope for the best!!!

Types of Equity Mutual Funds

We all know what a mutual fund is. A Mutual fund is nothing but a common pool of money collected from investors and managed by a fund manager who would buy/sell stocks on our behalf and share the profit/loss with us. To know more about mutual funds click here

If somebody is talking about mutual funds, almost always they talk about equity mutual funds.

What is an Equity Mutual Fund?

A MF scheme that invests at least 65% of its fund corpus into equity and equity related instruments is called an equity mutual fund. Equity funds carry the most risk among all kinds of MFs because they invest in the stock market. This risk comes with the potential of high returns.

Types of Equity mutual funds:

Based on the investing style equity mutual funds are broadly classified into 4 categories:

1. Equity Diversified funds
2. Equity Linked Saving Schemes (ELSS)
3. Index funds & ETFs
4. Sectoral Funds

Equity Diversified Funds:

These are actively managed funds that invest across stocks and sectors. They do not concentrate on only a few sectors or scrips but focus on either large-caps or mid and small caps. They could also be thematic, for instance funds focusing on rural growth or infrastructure. These funds are riskier than index funds because their performance depends on the fund managers abilities to buy and sell the right stocks at the right time.

The top 3 Equity diversified funds are:

1. ICICI Prudential Infrastructure fund
2. Reliance RSF – Equity
3. UTI dividend yield fund

ELSS funds:

ELSS are also diversified equity funds but offer income tax deduction under sec 80C up to a limit of Rs. 1 lakh. It also imposes a three year lock in period. You cannot redeem your units before the end of 3 years.

The top 3 ELSS funds are:

1. Sundaram BNP Paribas tax saver
2. SBI Magnum Tax gain
3. Fidelity Tax Advantage

Index Funds:

These are the simplest and least risky of all equity funds. They invest in all the scrips and in exactly the same proportion as the scrips lie in their underlying benchmark indices. While an index fund buys and sells scrips on the stock exchanges, an ETF (Exchange Traded Fund) appoints market participants. They exchange a basket of securities (whose composition exactly matches that of the benchmark index) against an ETF unit. These ETF units are then traded on stock exchanges like stocks.

While index funds can be bought or sold from the MF or through an agent like any other ordinary scheme, ETFs can only be bought and sold on exchanges, therefore you need a DEMAT account to buy/sell them.

Sectoral Funds:

These are the riskiest of all funds. They invest in a single or at best two or three closely linked sectors. Their fortunes depend on these select sectors & its stocks only. As their name indicates, the fund house buys/sells stocks only in the sector on which it declared to invest while offering the fund. If the sector that the fund house invests performs well then our returns would be more than a equity diversified fund or an index fund but at the same time, if a sector underperforms our returns would get affected adversely. These funds are not for the normal investor. It is only for high risk and knowledgeable investors who can actively track their portfolio and exit a sector before it is adversely affected.

Note: This is not a recommendation to buy the mutual funds mentioned in their respective categories. This is just an illustration to point out the best funds in the categories as per my view as of today April 5th 2009. The funds performance may change its ranking over the next few weeks/months/years.


Happy Investing!!!

Equity Linked Savings Scheme (ELSS)

With March just around the corner, people have started worrying about saving Income tax. Usually people throng investment options during February and March and try to save as much tax as possible. To know about the Indian taxation laws pls Click Here

As per our Indian IT laws every tax payer is eligible for savings under section 80C for amounts up to Rs. 1,00,000/- To know about the various options that we have to save tax under section 80C pls Click Here

This article is about Equity Linked Savings Scheme (ELSS). ELSS schemes are one the best tax saving instruments that have been offering great returns for our investor public over the years.

What are Equity Linked Savings Schemes?

An ELSS is a kind of Mutual Fund and is similar to any diversified equity mutual fund in many ways. An ELSS gives a tax benefit and comes with a lock in period of 3 years. Investment avenues of an ELSS are a mix of various asset classes such as equity, debt, gold and real estate.

Some advantages of ELSS are

* The 3 year lock in period prevents withdrawals and thus allows your money to grow over a period of time. Long term investment in equities gives better returns than any other investment instrument.
* It gives tax benefits (Up to 30% for people in the highest tax slab)
* Gives the flexibility to invest small amounts through a Systematic Investment Plan (SIP)

As an ELSS investor, your interests will be safeguarded by two separate market bodies. The Association of Mutual Funds in India (AMFI) and the Securities and Exchange Board of India (SEBI)

Let me explain the returns on an ELSS with an example:

Lets assume you invest Rs. 1 lakh this year in an ELSS scheme and you are in the highest tax bracket.

Invested Amount = Rs. 1,00,000/-
Income Tax saved = Rs. 30,000 (30% tax slab)

Net amount Invested = Rs. 70,000/- (I have deducted the 30,000 because you get it back up front after your investment as income tax benefit and you effectively invested only Rs. 70,000)

Let us assume your equity investment grows at the rate of 15% per annum.

Investment value at the end of the First year = 1,15,000/-
Investment value at the end of the Second year = 1,32,250/-
Investment value at the end of the Third year = 1,52,087/-

Assuming you encashed your investment at the end of the 3rd year you will get Rs. 1,52,087/-

Profit you realized = Rs. 82,087/- (You invested only Rs. 70000 effectively :) remember the tax saved)

Profit percentage = 117% (For 3 years together)

Returns % per year = 39%

A Returns of 39% per annum is something we cannot expect in any other form of investment. Thus ELSS schemes make one of the best investment options.

How is your ELSS Money Invested?

This is a very common question that people have. The asset allocation is pre-determined and is in accordance with SEBI guidelines. Between 60% to 100% is invested in equities, cumulative convertible preference shares and fully convertible debuntures and bonds of companies. Money market instruments account for anything between 0% to 20% The asset allocation shows a tilt towards equities which has the scope for providing good returns for us. The choice of industries and allocation to mid-cap and large-cap companies depends on the individual scheme & its fund manager. As an investor, we must first understand the objectives of the fund and also go through the offer document before investing.

Difference between an ELSS fund and a Equity Diversified Mutual Fund

Both ELSS and Diversified equity schemes have the same risk profile. Both are high risk - high return investment avenues. The major difference lies in the fact that an ELSS scheme has a lock in period if 3 years and a diversified equity scheme comes with no such conditions.

It is always advisable that Equity investments be made for the long term to help the fund outperform other asset classes. The lock in period for ELSS supports this view and also allows the fund managers to plan a strategy that would be beneficial in the long term. On the face of it, the 3 year lock in stipulation might be a deterent to investors, but it has its own advantages.

* By forcing us to wait 3 years, it makes us take a long term view of the market, which induces investing discipline to a certain extent
* The real potential for returns from equities can be realized only if we stay invested for at least a few years
* The fund manager knows that the investment would not be encashed in the next 3 years and hence they can plan and devise a strategy that can help us benefit. The manager can choose the sector and stock bets with freedom that he does not get in regular equity schemes

The performance of an ELSS and a diversified fund may also vary.

The difference in performance usually arises from the differences in managing styles and the market rewards for a particular style at a given time. ELSS schemes may have a small & mid cap bias. Fund managers may like to take advantage of the lock in period to exploit value stories in these sectors. Many diversified equity funds tend to have a large cap and growth bias. Therefore, during periods when growth stocks and large caps dominate, diversified equity funds would outperform ELSS Schemes.

But if we calculate the returns of ELSS schemes including the tax benefits we get out of it, they would outperform the diversified equity class.

Saving Income Tax through Investments

Every Indian who earns an income in India is entitled to pay tax on his income. As per the Indian tax laws we the tax payer is allowed to save his income tax by using the provisions under Sec 80C of the tax laws. To know more about the Indian Income tax laws and the options using which we can reduce our tax pls refer to this link. Income Tax

In this article we will be checking out some investment options that would help us save some cash for our future.

Why do we need to invest?

This is one big question that most of us have but we do not know the best answer. The most common answer is "To Save Income Tax".

Yeah that too is an answer but that is not the first of the reasons. There are a few other compelling reasons why we should invest.

1. Inflation - The Inflation rate of our country is currently at 11%. This means that anything you buy this year for Rs. 100 would be worth Rs. 111 next year. Next year our income would rise but so would our commitments. So if our money is not growing at least at the rate at which the inflation is going, then effectively the worth of our money is going down.
2. Future Income - Today we are in a good job and earning a decent income. After 20 or 30 years we would have to retire some time. After that we would not want to compromise on the life style we are used to. Nor would we want to be dependent on our children to support us. So what is the only option? We must save up some cash that we can use after our retirement. This is possible only by investment.
3. Financial Security - Financial security is something all of us would want to have. If anyone asks us what would make us feel financially secure what would we say? A bank balance of 10 lacs? Yeah that sounds nice. But how would we get such lump sum amounts? The answer is simple. If we start investing now, once our income earning days are over we would be able to sit on a pool of cash that would make us feel financially secure...
4. Saving Income Tax

I have intentionally placed Saving Income tax as the last option because, we must not invest just for the sake of saving tax. We must invest sincerely because we are the ones who is going to enjoy the fruits in future.

In my article on Income tax i have mentioned about 9 options that are available for us under Sec 80C to save tax. Out of these I am going to consider the investment options available. We would not be considering Life Insurance and Home loans because they are not investments but a protection and an asset for us. We will be looking at them one after the other in the increasing order of risk and also the increasing order of Returns.

Remember - "The Greater the Risk, Greater are the Returns" This doesn't mean that we must only in high risk instruments. Definitely not. We must have exposure to safe avenues of investment too because after all it is our hard earned money and we do not want it to go waste. We must maintain a good balance between risky investments and safe investments so that our principal is intact and at the same time our money must grow and beat at least the Inflation rate.


1. Provident Fund

All of us know what Provident Fund is. This is a portion of our salary that our employer deducts every month. This money is remitted to the government of India's PF trust. This money is used by our government for its cash needs. Once we retire or close our PF account, the money that has accumulated against our name would be given back to us. The money in our PF account grows at the rate of 8.5% per annum compounded every year.

Safety = Very high because backed by the government
Returns on Investment = Average - Our Inflation is 11% and the returns on PF is only 8.5%

Investment Strong points:
a. Extremely Safe
b. A small amount every month can help us make up a good corpus over the long run.

Downside:
a. Only average returns.

Note: Ever wondered why the government of India has made PF mandatory for all employers? Even the government wants us to save some money for our future. The best way is to make it mandatory at the source which gives us the income. We should be thankful to our government for doing at least some good things for us :-)

2. Public Provident Fund

PPF is similar to PF with the only difference being, anyone can open a PPF account by visiting the nearest State Bank of India branch. PPF is also managed by the government of India. Once we open a PPF account we can deposit cash in our PPF account anytime. There is one restriction here. We must deposit at least Rs. 500/- every year to keep our PPF account active. The maximum amount we can remit in our PPF account every year is Rs. 70,000/- Our PPF account remains active for 15 years and if we want we can extend it by a further 5 years. We cannot encash the entire amount in our account before the tenure of 15 years. Of course we can do partial withdrawals from our account but we cannot take out the entire corpus.

Safety = Very high because backed by the government
Returns on Investment = Average - Our Inflation is 11% and the returns on PPF is only 8%

Investment Strong points:
a. Extremely Safe
b. A decent amount deposited every year can help us make up a good corpus over the long run.

Downside:
a. Only average returns.
b. Very long lock in period. We cannot take out our cash before 15 years
c. We need to deposit at least Rs. 500/- every year to keep the account active.

3. National Savings Certificate

NSC certificates are certificates of deposits issued by the government of India. Any Indian can deposit cash in NSC. This money would be used by the government for its cash needs. NSC gives us a return of 8% per annum compounded every half year and we can get our amount inclusive of the interest at the end of 6 years. 6 years is the lock in period on NSC certificates. Since these certificates are issued by our government they are extremely safe.

Safety = Very high because backed by the government
Returns on Investment = Average - Our Inflation is 11% and the returns on NSC is only 8%

Investment Strong points:
a. Extremely Safe
b. A decent amount deposited every year can help us make up a good corpus over the long run.

Downside:
a. Only average returns.
b. Long lock in period. We cannot take out our cash before 6 years
c. The Interest earned on NSC is taxable

4. Bank 5 year Fixed Deposits

The latest addition to the tax saving investment options is the Bank 5 year fixed deposit. We can deposit our cash in this special scheme of fixed deposits in any bank. Most banks give us returns as high as 10% for these deposits. The money we deposit is locked in with the bank for 5 years after which we can take back our money. We can opt for periodic interest payments or we can get the interest along with the principal at the end of 5 years.

Safety = High because backed by the RBI
Returns on Investment = Average - Our Inflation is 11% and the returns on FD's is only 9% or 10% max

Investment Strong points:
a. Very Safe
b. A decent amount deposited every year can help us make up a good corpus over the long run.

Downside:
a. Only average returns.
b. Long lock in period. We cannot take out our cash before 5 years
c. The Interest earned on Bank FD's is taxable if it is more than Rs. 10,000/- per annum.


5. Equity Linked Savings Scheme (ELSS)

ELSS mutual funds are a category of Mutual funds that are exempt from Income tax. To know more about Mutual funds Click Here

ELSS mutual funds are special funds that invest predominantly in Large cap stocks (Companies that are very large with exceedingly high capability of profit making, that have been successful for a number of years) ELSS funds have a lock in period of 3 years after which we can take our money if we want. Since the money we invest is invested in the Share market, the returns are not constant. In years in which our market performs well we can expect exceptional returns but at the same time it carries a risk. If our markets perform poorly we may incur losses. But over the years, the Indian share market has been able to give a returns of at least 15-20% year on year.

Safety = Low, because the money is linked to the share market.
Returns on Investment = Very high - If the share market goes up, our returns may exceed 20%. In the past 2 years until Jan 2008, our markets have dished out returns as high as 50%

Invest Strong Points:
a. High returns
b. A small amount investment every month can help us accumulate wealth over the years.
c. Short lock in period. ELSS is the only investment option that has a lock in period of only 3 years.
d. Returns on ELSS are tax free. Both Dividends and the maturity amount.

Downside:
a. High risk because it is linked to the stock market

The most important point:

This is the most important point of this article. "Starting Early"

Starting Early means, starting investing at a young age. Assuming two friends A & B start investing. A is 25 years old and invests Rs. 50,000/- every year for the next 20 years. B is 35 years old and invests Rs. 1 lac every year for the next 20 years. Who do you think will have more cash by the time they are 60 years old?

If you said B then you are wrong. A would have more money because he started early. His investments were able to earn an income on themselves for 35 years which was 10 years more than B's investments.

Assuming you can invest Rs. 1 lac every year for the next 25 years in an instrument that gives you a returns of 10% per annum. By delaying your investment by one year your corpus would fall short by Rs. 3.5 lacs at the end of 25 years. That is the power of compounding. The interest you earn this year would earn interest for you next year. So Start Early :)

Happy Investing...