These schemes also allow investors to take equity exposure at low risk

A little over two months remain in the current financial year for you to invest in those financial products that allow you to reduce your tax burden. In the Budget for the current fiscal year, the government has allowed investors to save Rs 50,000 more in a select list of financial products that will cut your total tax burden. Of all the products that are available for saving taxes, financial planners and advisers say that Equity Linked Saving Schemes (ELSS) from mutual fund houses are one of the best that investors should consider, provided their risk profile matches the risks associated with these products.

As the name suggests, an ELSS is a mutual fund scheme which invests at least 65% of its corpus in equity and equity linked products to avail of tax benefits for investors. The minimum 65% investment is mandatory for the fund to avail of exemptions under the long-term capital gains tax rules of the Income Tax Act.

As an individual investor, you can invest up to Rs 1.5 lakh each year via the ELSS route to avail of tax benefits under section 80CC of the Income Tax Act. For this, you should also stay invested for at least three years, which is called the lock-in period for these schemes. If you want to withdraw your investments within three years of making the investment, you have to forgo the tax concessions that you had availed of.

According to mutual fund industry officials, an ELSS is one of those instruments that are open-ended in structure and, at least for three years, the investment horizon of the investor matches with that of the fund manager. In these schemes, the fund manager is less concerned about the outflow from his fund midway through the investment cycle than in other open-ended schemes from which investors can exit at any point of time. This character of ELSS funds also allows the fund managers to perform better, say industry officials.

According to Value Research data, while funds from several other mutual fund categories have given higher returns than the ELSS over a five year period, they carry higher risks. Data shows FMCG funds have given a return of 26.3%, compounded annually, and pharma funds nearly 24%, while ELSS schemes have given a compounded annual return of 13.6%. In comparison, low-risk funds like large-caps have given an average return of 11.1%.

Another advantage of these tax-planning funds is that the returns you get are fully tax-free in your hand.

Financial planners and advisers pointed out that among the tax-saving instruments notified by the government, ELSS has the shortest lock-in period. Compared to PPF where the lock in is for seven years and notified tax-saving bank FDs are locked in for five years, the lock-in for ELSS is just three years.

In ELSS, you can invest through growth as well as dividend options. However, earlier this month, due to various technical issues related to taxation, the dividend re-investment option has been withdrawn for these funds.

Industry officials and financial planners also point out that since it is preferable to plan your tax-related investments for the full year rather than just for the last three months of the financial year (January-February March, or JFM months in market parlance), it is always better to invest in these schemes through the systematic investment route, commonly known as the SIP route.

There are some risks too.

Since these funds are equity heavy, in case the stock market goes down or is sluggish, the returns on your investments in these funds could also suffer, according to financial planners.