Tax-free equity MFs give better long-term returns than FDs

    Income tax planning is an integral element of personal finance. People who have not done their tax planning for current the financial year yet can use the remaining four months of the current fiscal to build a portfolio of investments that will not only allow them tax savings but also give them an opportunity the build a long-term corpus, say a retirement fund for their sunset years. 

Section 80C deductions 
This section of the Income Tax Act allows deduction (totalling up to Rs 1 lakh) from the taxable income in respect of certain investments. The popular investment options in this section are Public Provident Fund (PPF), taxsaving bank fixed deposits and specified equity mutual funds (ELSS). 
PPF: The interest on PPF is market linked (presently tax free 8.8% per annum, compounded annually). The minimum tenure of the PPF account is 15 years, which can be further extended twice in blocks of 5 years each. 
Select bank FDs: These fixed deposits have a lock-in period of five years and pay about 8.25%pa taxable interest. The annual interest on these deposits gets added to the taxable income and gets taxed at the highest tax slab the investor is in. 
Equity-linked savings schemes: As the name suggests, these schemes invest in equities. The units of these schemes are offered at the net asset value (NAV). Since investments in ELSS are subject to market risks, investors mustassess their risk profile before investing in such schemes. A practicing financial planner is best equipped to assess the risk profile and suggest an appropriate scheme to invest in. 
    ELSS though has a mandatory lock-in period of three years (the shortest lock-in among all options under section 80C), they are positioned as long-term equity investments and returns are tax-free in the hands of the investor. Investors should ideally stay invested for a longer term as equities generate best returns over a longer time frame and should also remember that the power of compounding also works best in the long term. 
    Besides tax savings, ELSS are good investments too as the three-year lock-in keeps a check on the bouts of greed and fear that the investors generally struggle with when markets turn volatile. 
    In the last 10 years, the various ELSS schemes have delivered between 15-32% compounded yearly returns. The table illustrates the superior wealth creation potential of ELSS investments, assuming returns of 15% compounded per year (that of the worst performing ELSS scheme in the last 10 years) and 30.90% tax on earnings from bank deposits. An investment of Rs 1 lakh per year in ELSS schemes can create a corpus of over 1 crore in 20 years, over Rs 4 crore in 30 years and over Rs 17 crore in 40 years. 
    The author is 
    CEO of Prime Capital 
    Services, New Delhi NEXT WEEK 
    Every year, the Armed Forces Flag Day is celebrated on December 7. Next week, we will take up financial planning for people from the armed forces.