This is the time of the year when you would be gathering your medical bills for supporting medical allowances, petrol bills for transport allowance, boarding passes for claiming LTA, insurance receipts, donation receipts, etc. This is also the time when many of us would be investing in various tax saving products to avail maximum tax exemption.
Equity Linked Saving Schemes have proved their mettle over the years. It is the most preferred option for many investors when in comes to saving taxes because of a number of factors like high returns, highest liquidity among all tax saving instruments under section 80C of the Income Tax Act, easy application and withdrawal, etc. If we look at the performance numbers alone, the average return generated by ELSS schemes over the past three years, five years and fifteen years is 18.34%, 17.36% and 20.27% respectively. (Average of 31 ELSS Mutual Fund Schemes. Data as of 31st Dec 2016). These numbers are greater than any other tax saving instrument in India.
For many people, investing in saving tax instruments is their only investment in the year. And investors often tend to replay their investments. Replaying investments means redeeming your tax saving investments on maturity and reinvesting the same amount for your current tax saving investment requirement. ELSS schemes as we know are good performers in terms of returns and are the best investment option if we consider liquidity. Investors are often tempted by the small lock in period of three years and they invest with the intention to ‘Replay their Investment’.
The idea behind tax saving is investing for your future, investing for fulfilling goals and not just saving immediate taxes. And ELSS schemes are also based on the same notion. The lower lock in of ELSS is intended to give you the flexibility of withdrawal in case of emergencies. Your present survival is more important than your future wealth. So if after five years, you are in dire need of money and your tax savers are of no use, because of long lock ins, the entire purpose of saving gets defeated. But then it doesn’t mean that you withdraw your investment after exact 3 years even if it is not an emergency.
Why should you not recycle your ELSS investment?
Consider an example, Karan Kapoor and Arjun Kapoor are brothers and both of them are living and working in Mumbai. The Kapoor brothers invested Rs 1 Lac each in ELSS schemes in the year 2014, Rs 1 lac in 2015 and another lac in 2016. Now they have to invest for 2017. Karan decides to keep his existing investments intact and he makes a fresh investment of Rs 1 lac for this year and for the years to come. While his brother Arjun feels that it is better to redeem his 2014 ELSS, since it will now mature and he can direct the same money into his 2017 tax saving commitment, and the subsequent years will follow.
Who is on the right track?
Let’s analyse which brother has the right approach:
1. Karan will be saving and investing fresh 1 Lac or even more each year. Therefore he is accumulating a greater corpus for his future and will be in a much better position than Arjun in meeting his various life goals and emergencies. Arjun on the other hand is eventually not saving anything after three years. His investment is just Rs 3 Lacs, and this a tiny sum for his entire future.
2. ELSS schemes are market linked. They are managed like any other equity scheme and are hence ideal long term investment products. Karan’s investment may fall or rise, he has no plans to withdraw. Arjun on the other hand will withdraw every year, the markets may or may not be in his favour. Hence there are greater chances of losing out on returns and even on the principal.
3. Karan will reap the benefits of long term equity growth, while Arjun will end up Replaying his Investment only.
4. Since Karan is committed to investing regularly, he is eventually saving extra, he has a more disciplined approach to investing. Arjun on the other hand is not saving after three years will be spending all his savings and compromising on a safe financial future. This is disrupting his saving discipline and long term financial security and goals.
The above factors clears that Karan Kapoor is following the right approach. It shows us why we should be smart like Karan, and not Recycle our ELSS investment. Rather invest with the objective of holding it for the long term. Do not redeem until you are in an emergency or a financial goal is approaching. You must remember it is not a mere tax saving instrument, but an investment for fulfilling your life goals.