ELSS vs Equity: Which is Best For Tax Saving?

When it comes to tax-saver mutual funds while investing in the stock market, investors often find themselves comparing Equity-Linked Savings Schemes (ELSS) with direct equity investments. Both avenues offer exposure to equity markets, but they come with distinct features, especially regarding tax benefits, risk, and investment horizon. Understanding these differences can help investors make an informed choice that aligns with their financial goals and tax-saving needs.

What is ELSS

ELSS mutual funds invest their major portion of their corpus in equities. These schemes come with a dual advantage: the potential for high returns due to equity exposure and tax benefits under Section 80C of the Indian Income Tax Act. Investments in ELSS are eligible for a tax deduction up to Rs. 1.5 lakh per annum, with a lock-in period of just three years, the shortest among the tax-saving investments available under Section 80C.

What is direct equity investment

Direct equity mutual fund investment involves buying shares of companies directly through the stock market. This option appeals to investors looking for high returns by investing directly in the stocks of their choice. While there is no upper limit on investment and no lock-in period, unlike ELSS, direct equity investments do not offer any specific tax benefits for the amount invested. However, long-term capital gains from equities are taxed at a favourable rate, which can be considered a tax-efficient feature of equity investments.

ELSS vs. Equity: Key differences

1. Tax benefits

• ELSS: Offers upfront tax deductions under Section 80C up to Rs. 1.5 lakh per annum.
• Equity: It does not provide tax deductions on the investment amount, but long-term capital gains over Rs. 1 lakh are taxed at 10% without indexation benefit.

2. Investment horizon and lock-in period

• ELSS: Has a mandatory lock-in period of three years, making it suitable for investors with a medium-term horizon.
• Equity: There is no lock-in period, offering flexibility to investors who might want to enter or exit based on market conditions or personal preferences.

3. Risk and return

• ELSS: Diversified across various sectors and companies, potentially reducing risk while still offering attractive returns.
• Equity: Risk and return depend on the chosen stocks and the investor’s research and decision-making skills.

4. Investment approach

• ELSS: Managed by professional fund managers, suitable for investors who prefer a hands-off approach.
• Equity: Requires active involvement, research, and monitoring of the market and companies, appealing to hands-on investors.

Which is best for tax saving

The choice between ELSS and direct equity investments for tax saving depends on your investment goals, risk tolerance, and investment horizon.

• If you are looking for a disciplined investment option that offers tax savings with the potential for attractive returns and are comfortable with a lock-in period, ELSS could be the ideal choice.
• On the other hand, direct equity investments might suit you better if you are more focused on potentially higher returns, have the capability to research and select stocks, and value liquidity without immediate tax-saving needs.

Conclusion

Both ELSS and direct equity mutual funds have their place in a diversified investment portfolio. For tax-saving purposes, ELSS stands out due to its specific tax benefits under Section 80C and the relatively lower risk through diversification. It is also important to understand tax slabs of FY 2024-25 for tax saving purpose. However, for investors looking beyond tax savings who are keen on building a portfolio tailored to their risk appetite and investment goals, direct equity could offer more flexibility and potentially higher returns. Ultimately, the best choice depends on your financial objectives, investment horizon, and risk tolerance.

The strategic incorporation of tax-saver mutual funds and equity mutual funds into an investment portfolio can significantly enhance an investor’s financial landscape. Tax-saver mutual funds provide tax benefits, making them an attractive option for individuals looking to reduce their taxable income and potentially offer the growth associated with equity investments. Similarly, equity mutual funds, known for their potential to deliver higher returns over the long term, become even more appealing when paired with the tax-saving features of tax-saver mutual funds. This combination allows investors to enjoy the best of both worlds: the growth potential of equity mutual funds and the tax efficiency of tax-saver mutual funds.

By judiciously allocating investments between tax-saver mutual funds and equity mutual funds, investors can achieve a balanced approach to both wealth accumulation and tax optimisation. Ultimately, the judicious use of tax-saver mutual funds alongside equity mutual funds can lead to a robust and efficient investment strategy, maximising returns while minimising tax liabilities.