Invest for 3 years – Save Tax For LIFETIME!

Recently I came across this headline “Invest for 3 years – Save Tax For LIFETIME”. Sounds eye catching right? Because for many of us tax is the only force which makes us invest. Let us try to understand such GIMMICKS  in detail 🙂

Invest for 3 years - Save Tax For LIFETIME

Here, the product recommended for investment is ELSS (Equity Linked Savings Schemes) or Tax Savings Equity Mutual Funds. Hence, let us quickly understand what is ELSS or Tax Saving Equity Mutual Funds.

Which mutual funds are considered as ELSS or Tax Savings Funds?

ELSS or Tax Savings Funds were first introduced in the year of 1991. The maximum limit to claim was Rs.10,000 under the Sec.80CCB. Then this section was merged with IT Sec.88 with the same limit for ELSS Funds.

Later on, this Sec.88 was replaced with current Sec.80C. This Sec.80C has become effective from 1st April 2005 (FY 2005-06 or AY 2006-07). The current maximum limit for ELSS investment is Rs.1,50,000 per year.

These ELSS Funds comes with lock-in. Let us say you invested Rs.1,50,000 on 15th June 2017, then you are eligible to withdraw it only after 15th June 2020. Same way let us say you started a monthly SIP of Rs.10,000, then each such SIP is considered as a fresh investment.

Hence, each such monthly SIP must complete 3 years to be eligible for withdrawal. Let us say you started a monthly SIP of Rs.10,000 from 15th June 2017, then the 15th June 2017 month SIP will be eligible for withdrawal after 15th June 2020. The next month SIP i.e. 15th July 2017 month SIP will be eligible for withdrawal after 15h July 2020. This will continue for the next months.

Such ELSS funds invest in 80% equity and convertible bonds at all times. They can hold 20% in cash or money market instruments to handle redemptions. The 80% equity can be managed as per the wishes of the AMC. They can be large-cap, multi-cap or mid-cap funds.

Hence, all ELSS FUNDS ARE NOT SAME. They may be an equally risk like a small cap or mid cap funds. Risk varies based on the underlying stocks or portfolio.

Also, note that ELSS funds can only invest in equities and bonds that are convertible to share. Investing in Arbitrage opportunity like Arbitrage Funds is not allowed.

Liquidity or lock-in feature in ELSS or Tax Saving Funds

As I pointed above, investors will not be eligible to withdraw the money for the three years from the date of allotment of units. However, in case the death of investor, nominee or legal heir can come out from the investment only after the completion of one year from the date of investment. Hence, even in a case of death also, your nominee or legal heir has to wait for a year to liquidate the investment.

Hence, if investor alive then he can liquidate the investment after the three years completion. If he dies, then his nominee or legal heir can liquidate the same after a year of completion from the allotment of units.

When it was first replaced with Sec.88 in the year of 2005, then the limit was Rs.1,00,000 a year. Now it is at Rs.1,50,000 a year.

Invest for 3 years – Save Tax For LIFETIME!

Now you get a fair idea about ELSS funds. Let move on to the topic, which we are discussing.

As per this, you have to invest Rs.1,50,000 a year for 3 years. After 3rd year completion, you have to withdraw the money which you invested in the first year and re-invest the same in ELSS funds and claim the rebate under Sec.80c. Same way you have to withdraw the second year invested money in the 5th year and invest uunderELSS. This will continue as long as you alive.

Let us say you invested Rs.1,50,000 in FY 2017-18.

Again you invested Rs.1,50,000 in FY 2018-19.

One more time you invested Rs.1,50,000 in FY 2019-20.

Then, you are eligible to withdraw the money you invested in FY 2017-18 in the year of FY 2020-21. You withdraw the money in FY 2020-21 and reinvest the same in ELSS Funds and claim the benefit under Sec.80C. You continue this throughout your life (Assuming you invested lump-sum for the first three years and same lump sum you are investing in future).

As such ELSS are considered as equity funds, the returns which you receive from such funds are exempt from tax (if holding period is more than a year).

Sounds GOOD!! Now worries of tax saving or no fresh fund required to save tax. Route the same old invested amount into ELSS and claim benefit throughout the life.

However, such logic not works when it comes to equity investment. Reasons are as below.

# Enter into equity if your holding period is more than 5 years.

Many of us enter into ELSS because it is tax saving instrument which is having minimal lock-in when you compare with other tax saving options.

But do remember that this is the equity product and above that, you are not sure the underlying stocks. Hence, you must enter into equity (or ELSS) only if your holding period is more than 5 years and that also with proper asset allocation.

If you follow this rule, then you are unable to follow that GIMMICK.

# Investing does not mean Tax Saving

Many of us feel that we have to invest because we have to save tax. But the reality is, you must identify the goals, then based on the goals time horizon and risk appetite you have to choose the asset class or products. While choosing the products, you may look for tax-efficient products.

However, we are doing the reverse. We first choose the product which is eligible to save tax. Then we think about rest of the ideas.

If you follow this rule, then you are unable to follow that GIMMICK.

# ELSS is not TAX SAVING BANK FD or NSC

Many used to follow this strategy of re-investing into tax saving instruments by using the Tax Saving Bank FDs or NSC products. But they have definite returns declared at the time of an investment itself.

Hence, it is not worrisome. However, in a case of ELSS, it is market linked. Let us assume that you invested Rs.1,50,000 today and due to crash in the market, the same may be valued at Rs.1,00,000, then you still go ahead and liquidate after 3 years as you have to save tax??

NO right? Hence, it is better to understand the volatility or risk involved in a product rather than blindly using some gimmick.

# This is the Mutual Fund Advisers GIMMICK 🙂

Yes, this logic is created by mutual fund advisers. If you follow this gimmick, then their income is also GUARANTEED as long as you are alive. Because you are in a trap called TAX SAVING and they are getting their income as long as you invest and hold the same.

# You lose habit of investing

Because of this trap, you just routinely redeem and re-invest in ELSS funds. In such situation, the fresh investment may be diverted to spending or somewhere. This leads to big financial hazard especially when it comes to accumulating the wealth for long-term goals like kids education or marriage and retirement.

The more you invest from your savings leads to reaching your financial goals at the early. Hence, this gimmick makes you away from saving and investment habit.

Considering all these above points, do you still feel the idea of “Invest for 3 years – Save Tax For LIFETIME!” worth to implement and that also with the product like ELSS??

27 Comments

  1. Sir.
    1. It will work, and also build a corpus. e. g. Start a SIP of 12500/pm and after 37 installments start a SWP for 12500 so it will be a self sustaining activity.
    2. The 1st installment of the SIP, @10% annual increase will be approx 16500, so remaining 4000 will contribute towards corpus.
    3. As regards 5 years period for eq investment, if one withdraws after 37 month and immediately reinvest ( due to SIP and SWP dates being same) 3 or 5 years is academic.

    Reply
    • Anand-How you assumed 10% return for 3 years of investment??

      Reply
    • Either ways, your capital remains just 4.5 lacs. So you will get only whatever returns that 4.5 lac principal is able to get you. For example, let us say you invest 1.5 for 3 years and then the market gives 12% CAGR for next 25 years. Your final corpus would be 76.5 lac. Assuming 6% inflation, that corpus would be equivalent of 17.83 lacs only. Now assume you did a SIP of 12500 for 25 years without this rotating strategy. Your invested capital would be 37.5 lacs and corpus would be 2.4 crores. That is equivalent to a corpus of 87.5 lacs today. Now that is a corpus! Also if you do this strategy in case of bare market phase, you will book your losses permanently and put lesser amount of capital to work.

      Reply
  2. Dear,

    I have blindly started SIP in ELSS called.
    1. Axis long term equity fund.
    2. ABSL tax saving 96.

    &

    3. Mirae Asset Bluchip fund.

    My goal is to go with it long term .

    What is risk involve with. What should I keep in mind.

    Could you elaborate a bit.

    Reply
    • Sameer-It is hard for me to guide anything with your mere two lines of sharing.

      Reply
  3. Hi,

    I understand buying ELS and redeem after 3 yrs is not useful but buying ELS say for tax exemption and holding it for long terms say 5 yrs is it not a good option ?

    Reply
    • Akash-Good option when you know how to handle risk and when your goal is long term.

      Reply
  4. Dear Basavaraj,
    I am regular reader of your blog and really appreciate your ideas and suggestions. I agree with most of the article but “Invest for 3 years – Save Tax For LIFETIME!” is very useful for someone who is not availing 80C because his income is taxable but those who can’t save because of expenses, loan, education.
    For example Mr. X is earning 8 lakhs and he is not able to save much (may be 50-60K/year is saving) so for the first 3 year he can use this strategy. He have to save somehow 1.5K for 3 year and rest of the life he can enjoy the tax benefit. I give example of my friend to whom I suggested to break the 3 LIC is 3 different year for appox. 1 lakhs each and take the benefit of this plan with the rule that, not matter if market go up or down, he will invest all the money he will withdraw in 4th year from 1st year elss again to elss only. so this way i created a pool for him for lifetime in direct plan.

    After withdrawining the money, in 4th year if the person is strictly putting money again in ELSS, then he is not unfollowing the rule no 1 “Enter into equity if your holding period is more than 5 years.” because he is withdrawing but reinvesting so return and risk will be same. volatility or risk involved is also same if he is investing. Though it is Mutual Fund Advisers GIMMICK but very useful for many of us who is not saving alot/who does have alot of liabilities so despite earning and paying tax, they can’t invest much. Importantly, alot of people are like this only.

    Thanks

    Reply
    • If person is doing for very long term (more than 10-15 years) then asset allocation is not really important, atleast history says that.
      Or
      if he really want to do then he can do 1.5 L for ELSS year 1,2,3 and 2L year 4 in Debit fund so by investing 6.5 lakhs he is allocating the equity and debit ratio of 70:30 and saving also. If his equity money is increase after 3 years then he can rebalance with debit part if he want.

      Offcouse, if he get more money in between he can go for balance fund to keep the same ratio.

      Reply
      • Prem-Asset allocation be handy when market start to fall. It is easy for anyone to take two points of years and arrive at conclusion. May I know which history you are talking about? Here, the question is using equity asset class for rechurning at every 3 years.

        Reply
        • Dear Basavaraj-
          1) Asset allocation- I have already told that how to reach at 70:30 ratio (which most of the people follow) for long term goal. 3years ELSS and 1 year debit fund.
          2) History- says that if you invest in starting of year lumpsum vs SIP, in long term it is not going to affect, if your goal is long term
          3) equity asset class for rechurning at every 3 years.- where is rechurring, withdraw and reinvest evey 3 year.. fund will have same value if invested in same fund for 5 time rechurning every 3 years (=15 years) vs keeping the money in same fund for 15 years. take any fund and calculate it will be almost same. moreover person if really want can also change one ELSS to another ELSS anyway if he want.

          Offcouse this is suitable for- if person is thinking about long term and really investing about LONG TERM independent of NOISE.

          Reply
          • Prem-1) MOST PEOPLE TO BE FRANK DONT KNOW WHAT IS ASSET ALLOCATION. This is applicable to few advisers and media, forget about poor investors who depends on these.
            2) Proof?
            3) So you are confident that the fund which performing well today will perform well forever (of at least for next 3 years) and hence we must withdraw and invest continuously in the same fund.

            Reply
    • Prem-Do you feel ELSS suitable for 3 years investment ONLY because it’s lock-in is 3 years set by Govt?

      Reply
      • offcouse no, Sir you are missing the big picture what I am trying to say. I think we are talking same thing but saying 2 different scenario. If somebody can really spent 1.5L every year, I still stand with my point (which is also your point here) that he/she should invest every year rather than for 3 years and then circulating the same money.

        BUT what point I am trying to make here is, as written in the first comment that ” Circulating the same money is very useful for someone who is not availing 80C to FULLEST(1.5Lakhs) as he can’t save because of expenses, education etc.” so if the person may be is earning 6 lakhs but saving little like 50-60K/year because of education of child then that strategy can help him reduce paying less taxes. I have never said that “ELSS suitable for 3 years investment ONLY” but recirculating the same money for long term benefit for example 3 year circulation 4-8 time depend on the long term goal.
        offcouse, if he get extra, he can put in balance fund with asset allocation.

        Reply
        • Prem-I understood your point behind circulation. But here my point is they don’t know when they need money (in many cases), they are not doing the proper asset allocation, they don’t know that ELSS products (especially the underlying market cap or stocks). Simply with blind faith they start investing as if in earlier people use NSC or any fixed instrument for tax saving and repeating the same forever. This is bad which I am pointing.
          Question is, how many of us understand the risk involved in ELSS and how many of us understand the importance of asset allocation? Many don’t know how to review portfolio. If we suggest such idea to them, then it is devastating.

          Reply
          • So what you are suggesting to those people who can save 60-70K/year but now 1.5L every year but still pay- 20 to 30% tax? Have you got better than that for long term?

            Offcourse, i am assuming that person have emergency fund, health insurance and term plan so I don’t think they will need all the money suddenly as those are prerequisite for life whether you do mutual fund or not.

            Infact many bloggers including you advocate for goal based investment so they anyway know when they will need money so if person is clear with plan then it will work. In counter argument, I can say that normal investor also don’t know when they will need money so should they stop investing in mutual fund?

            if person is not clear with goal then usual mutual fund itself can not work for him. In my previous comments, I have already discussed about asset allocation (3 year 1.5L ELSS and 2L Debit fund) so there is no point going again and again on that.

            Reply
            • Prem-SAVING TAX ONLY A SOLE CRITERIA OF INVESTMENT?? Who is a normal investor? Who DOES NOT HAVE ANY FINANCIAL GOALS r those WHO UNABLE TO IDENTIFY THEIR FINANCIAL GOALS? “if person is not clear with goal then usual mutual fund itself can not work for him”, HOW?? and WHY NOT OTHER ASSETS??

              Reply
              • Dear Basawaraj, could you please answer my questions before we jump to another question that you asked?

                Reply
                • Prem-May I know once again your specific question, which you need my answer?

                  Reply
  5. Hello Sir,

    I read most of your articles and they are very helpful for new investors.

    l have a query, I would like to buy new 2 BHK flat approx price 65-70L , I have saving of 10L, which investment plan I should follow to create down payment of approx 20-25 % for this purchase for next 2-3 years.
    I own 1 bhk flat with month EMI of 30k as joint loan.

    Please advice .

    Thanks
    Mahesh

    Reply
  6. While I agree with your views, here is one counterview:
    1. Instead of 3 years, this can extended to 4 or 5 – and then the cycle can start.
    2. Instead of being CONvinced into taking up poor cover, high premium LIC endowment policies, this is better
    3. One need not reinvest in the same elss fund when it comes up. One can pick the competitive fund on the 3rd or 4th year and start the cycle.

    There is some merit to the idea, that after the initial 3or4 yrs, the tax saving need not take up active action

    Reply
    • Sri-1) Without proper asset allocation between debt and equity, it is still risky to invest in ELSS for 4-5 years period.
      2) I am not at all comparing LIC or Endowment Policies with ELSS. So it is wrong to compare an apple with orange.
      3) Instead of a competitive fund, I select the fund which is SILENT and protect me during the free fall of the market.

      Reply
  7. Sir, pls give information regarding Education loan

    Reply
  8. Which is better , mutual funds or shares ,and where to get sincere advise
    from time to time,and again which mf to invest in, in balance funds or liquid funds
    or equity based mf , is it not confusing for a person to pick and choose especially for those
    who do not have relevant education background.

    Reply
    • Jawahar-NO Product on this earth is GOOD or BAD. Hence, which is BETTER is depends on YOU. Also, the sincere advice can be expected from YOU ( I mean by educating yourself than depending on anyone especially the so-called media experts TIPS). Choosing the product or fund depends on your financial goal and risk taking ability. Without knowing much about you, it is hard for me to say anything.

      Reply

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