FD vs ELSS – Which is better to invest money?

Tax Saver FD vs ELSS

Fixed deposits are the fixed income instruments which are offered by banks. They offer a fixed rate of return on the deposits. One has to deposit a minimum sum of Rs 1000 and for a minimum of 5 years for availing benefit u/s 80c. These can be easily opened with any bank branch or even online using net banking.

ELSS on the other hand is the tax saving instruments which primarily invests in equity and equity related instruments. The investment made in ELSS funds qualifies for tax deductions under section 80C. The returns in ELSS are not assured or fixed unlike FD’s. The returns are market linked and hence one is in a better position as they can earn higher inflation beating returns.

ADVANTAGES FOR INVESTING IN Tax Saver FD

• Assured returns.
• Flexible payout available i.e. monthly, quarterly or annually.
• No or very low risk.
• Suitable for conservative investors.
• Can be easily opened in the nearest bank.

DISADVANTAGES FOR INVESTING IN FD

• Low real rate of return.
• Not suitable for individuals in higher tax slabs.
• TDS is deducted by the banks.
• Lock in period of 5 years.

ADVANTAGES FOR INVESTING IN ELSS

• Have the minimum lock in period of just 3 years in comparison to other tax saving instruments like tax saver FD having lock in of 5 years.
• Higher real rate of return or inflation beating returns.
• No compulsory redemption after 3 years, one can stay invested as long as he wants to.
• Lower tax outgo as gains up to Rs 100000 are tax exempted in a financial year.

Now let’s discuss in detail how these two investment instruments differ from each other on various parameters.

1. RETURNS
ELSS funds invest primarily into equities. They are also allowed to allocate some portion of the assets across small and mid cap companies which help them in generating alpha (higher returns). The returns generated by ELSS funds are not assured and are market linked. While on the other hand Tax Saver FD’s provide assured returns which are low in comparison to returns generated by ELSS funds. On an average ELSS funds can generate around 15-18% on a CAGR basis while the interest rate offered by the India’s largest public sector bank SBI (w.e.f. 9/5/2019) is just 6.60% for tax saver FD of duration of 5 years.

2. SUITABILITY
ELSS funds are best suited for those investors who are risk lovers and want to earn higher reruns. Only those investors should invest in ELSS funds whose risk profile permits them to invest in equity. While on the other hand, conservative investors can take refuge under FD’s as the returns are assured and fixed. For eg. those who are approaching their retirement or are in their retirement period can invest in FD’s. However a person whose retirement is still far away should take exposure into equities through mutual funds.

3. RISK
The underlying investment in ELSS is shares, therefore it involves risk. However, one should not refrain himself from taking calculated risk based on one’s risk appetite.

On the other hand, there is almost no risk in case of FD’s but the returns they offer are also not very encouraging.

4. LIQUIDITY
ELSS funds have a lock in period of atleast 3 years from the date of investment. What this means is that you have to stay invested for atleast minimum 3 years. On the other hand, the minimum lock in period for tax saving FD’s is 5 years.

5. TAXABILTY
Interest income earned from the FD’s are fully taxable. They are added to the individual’s gross income and are taxed according to the applicable tax slab. What this means is that the individual in the highest tax bracket needs to pay tax @ 30%. Also, banks generally deduct TDS @10% if the interest income is beyond a certain limit. Currently, the limit is Rs.10,000 p.a.

While in case of ELSS, one has to pay tax @10% on long term capital gains of over Rs 100000 only. For eg. If your long term capital gains are Rs 99000, then you are not required to pay any tax on these gains, however if you have earned gains worth Rs 120000 then you have to pay tax on Rs 20000 (120,000-100,000) which comes out to be Rs 2000.

FAQs

Q1. Which one is better to claim 80C deduction - ELSS or FD?
A. Both the investment products allow deductions upto Rs 1,50,000 under section 80C. However, one must remember that the investment in only 5 year FD’s are eligible for tax deductions. What this means, that if you invest in 3 or 4 year FD’s you will not be able to claim any tax deduction. While on the other hand the lock in period in case of ELSS is only 3 years.

So one should always prefer ELSS (if one’s risk profile permits) over tax saving FD’s, as the former is capable of generating inflation beating returns.

Q2. Which is a better tax planning instrument, ELSS, 5 year Tax Saver FD or PPF?
A.

TAX STATUS

Where, E=Exempt and T=Taxable.

ELSS
Contributions and accruing gains are exempted from tax while on maturity gains are taxed.

5 year FD
Contributions and maturity amount are exempted from tax, however accruing interest is taxed every year.

PPF
Contributions, accruing interest and maturity proceeds are all exempted.

In case of ELSS, the long term capital gains of up to Rs 100000 are tax free, however any gain above this limit is taxed at a flat rate of 10%. On the other hand interest income from FD’s is added to the individuals’ income and is taxed according to tax slab rate. No tax whatsoever has to be paid in case of PPF, but one has to bear the lock in period of 15 years.

ELSS have an edge over the other two tax saving instruments because of the fact that they are capable of generating superior tax adjusted returns with a minimum lock in period of just 3 years. While in case of FD’s and PPF, the lock in period is 5 years and 15 years respectively.

Q3. What will be a better option, a mutual fund or a fixed deposit?
A. Fixed deposits provide assured returns with minimum risk. They are suitable for highly conservative investors. However if one is capable of taking some risk and wants to earn higher returns then one should invest in mutual funds. There are funds which invest in debt, equity or a mix of both. One may choose funds based on his risk profile, liquidity requirements and investment horizon.

Q4. Why should I invest in ELSS over 5 year Tax Saver FD’s as the former involves risk?
A. Yes, it is true that ELSS are risky investments but one should not forget that higher the risk the better will be the returns and ELSS have the potential of generating superior risk adjusted returns than FD’s over a period of 5 years. Hence, ELSS should be preferred over 5 years Tax Saver FD if one wants to create wealth over a period of time.

Q5. ELSS have generated around 15-18% returns in the past. Can I expect that they will continue to generate such kind of returns in future as well?
A. Well it is hard to say, as no one can predict future markets and the returns they will generate. But yes this is for sure that over a period of long term they will outperform any other tax savings instruments and generate superior returns.

Q6. Is my capital protected if I invest in ELSS?
A. ELSS funds primarily invests in equity shares and hence one cannot rule out the risk involved. However there are very few chances of losing capital over a period of long term.

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