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What ELSS, if not fixed deposits?


Both equity-linked savings schemes and long-term FDs help save tax. But what’s your risk appetite?

Equity-linked savings schemes (ELSS) help you save tax. But, so do tax-saver fixed deposits (FDs). What should you opt for?

The answer depends on your risk profile. But, before that, let’s take a look at what each offers, and entails. Investments in both ELSS and tax-saving FDs of up to ₹1.5 lakh per financial year qualify for tax deduction under Section 80C.

ELSS primarily invests in equities. On the other hand, tax-saving FDs are fixed income instruments offered by the post office and banks. Apart from being different asset classes, ELSS and tax-saving FDs also differ widely in terms of product features and taxation of returns.

Hence, a comparison of product features would help investors in making an informed choice between these two tax-saving options.

Capital protection

Tax-saving FDs from the post office and banks score high in terms of capital protection, especially when compared with market-linked investment products such as ELSS. Post-office term deposits come with a sovereign guarantee from the Government of India, and deposits in banks that are listed as scheduled banks by the RBI, are insured up to ₹5 lakh under the DICGC, an RBI subsidiary. This covers cumulative deposits of each depositor in fixed, recurring, current and savings accounts of up to ₹5 lakh with each scheduled bank in case of bank failure. If you are a low-risk investor, you must know that ELSS funds primarily invest in equities and that such investments are prone to inherent volatility of equity markets.

However, this risk can be mitigated and in fact, used to your advantage by investing through the SIP mode. SIPs, or systematic investment plans, ensure disciplined investments at periodic intervals. It also helps in rupee cost averaging during market corrections, thereby eliminating the need for market timing.

Certainty of rate

Tax-saver FDs pay a fixed rate of interest till the end of the deposit’s tenure, irrespective of any changes in the card rates during the interim period. Thus, they offer unparalleled certainty in terms of rate of returns. Currently, the interest rate on tax saver FDs offered by banks range around 4%-7.5% p.a., whereas the 5-year post-office time deposit currently offers an interest rate of 6.7% p.a. The returns generated by ELSS funds depend on the performance of their portfolio constituents.

Higher returns?

However, being an equity-oriented scheme, ELSS beats fixed income instruments in the long term by a wide margin. In fact, ELSS, as a category, generated average annualised returns of about 9%, 16% and 13% p.a. over the last 3-year, 5-year and 10-year periods, respectively. Tax-saving FDs of banks and post office come with a lock-in period of 5 years. Depositors can either opt for reinvestment option — wherein the interest component is reinvested till the end of the FD tenure — or for quarterly or monthly interest pay-outs, if available, to generate regular income.

In the case of ELSS funds, the lock-in period of 3 years is one of the shortest among all Section 80C tax-saving investment instruments.

Although it is always advisable to stay invested in ELSS schemes for the long term, the option to redeem just after three years offers much greater financial flexibility to investors.

ELSS investors can also choose to stop or pause their SIPs any time without incurring any penalty.

Minimum investment

The minimum investment amount for opening FDs in most banks and in the post office schemes is ₹1,000. However, they do not charge consumers for opening or maintaining an FD. In the case of ELSS funds, the minimum investment amount for most fund houses is ₹500.

Tax treatment

The interest income generated by FDs is taxed as per the applicable tax slab of the depositor. For an ELSS, the long-term capital gains (LTCG) exceeding ₹1 lakh in a financial year realised from equity and equity-related instruments such as ELSS and equity mutual funds, attract LTCG tax of 10%. ELSS funds offer greater tax efficiency, especially for those in the higher tax brackets. Moreover, the higher upside potential of equities over the long term allows ELSS funds that are performing well to generate much higher post-tax returns than FDs.

Capital protection and income certainty offered by tax-saving FDs would appeal to those having a conservative risk appetite. ELSS funds would suit those with a higher risk appetite seeking higher returns, greater liquidity, tax efficiency and long-term wealth creation.

While picking an ELSS scheme, make sure you compare the performances of various ELSS funds over the last 3-year and 5-year periods with their benchmark indices. Although past performances do not guarantee future ones, comparing funds will help you understand how they dealt with various economic conditions and market cycles in the past.

(The author is CEO & Co-founder, Paisabazaar.com)

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