ELSS vs Tax Saving FD: Which is the Better Investment Option?

When it comes to saving taxes while investing, two popular options that come to mind are Equity Linked Saving Schemes (ELSS) and Tax Saving Fixed Deposits (FD). These investment avenues allow individuals to claim tax exemptions under Section 80C of the Income Tax Act, 1961, up to ₹1.5 lakh per financial year. However, both come with their own set of benefits, risks and return potentials. To make an informed choice, let’s dive into a comparison of ELSS and tax-saving FDs, keeping your financial goals in mind.

What is Common Between ELSS and Tax Saving FD?

Both ELSS and tax-saving FDs provide tax benefits, but the two investment options serve different purposes for different types of investors. Here’s what they share:

• Tax Deduction: Both investment types offer tax exemption up to ₹1.5 lakh under Section 80C.
• Lock-in Period: While both come with a lock-in period, ELSS requires you to stay invested for 3 years, while tax-saving FDs have a 5-year lock-in.

Key Differences: ELSS vs Tax Saving FD

The most significant difference between these two options lies in their risk and return potential.

• Risk and Returns:

• ELSS: These are equity-based mutual funds that invest primarily in the stock market. As a result, the returns are market-linked, and there is a risk of capital loss. However, ELSS has the potential to generate higher returns over the long run. Historical data shows that ELSS funds can deliver annualized returns between 20-30% based on market performance.
• Tax-Saving FD: Fixed Deposits offer guaranteed returns, making them a safer option. However, the returns are significantly lower, typically ranging between 6.5% to 8%, depending on the bank. The interest rate is predetermined and does not fluctuate with the market.
• Tax on Returns:

• ELSS: The profits you earn from ELSS investments are taxed as long-term capital gains (LTCG) if you withdraw after the 3-year lock-in. The LTCG tax is 10% on gains exceeding ₹1 lakh in a financial year.
• Tax Saving FD: Interest earned on tax-saving FDs is fully taxable as per the investor’s income tax slab. There are no exemptions on the interest income.
• Investment Flexibility:

• ELSS: You can choose to invest in ELSS through lump sum or systematic investment plans (SIPs), making it more flexible.
• Tax Saving FD: FDs require a lump sum investment, offering no scope for periodic or systematic contributions.

Returns Comparison: ELSS vs Tax Saving FD

To understand the return potential of both options, let’s compare their past performances.

ELSS Returns (5-Year Average Annual Return – CAGR):

1. Quant ELSS Tax Saver Fund: 37.61%
2. Bank of India ELSS Tax Saver Fund: 28.63%
3. SBI Long Term Equity Fund: 27.87%
4. Motilal Oswal ELSS Tax Saver Fund: 26.69%
5. Parag Parikh ELSS Tax Saver Fund: 26.47%

These figures clearly show the superior return potential of ELSS over a 5-year period. However, the returns are not guaranteed and depend on market conditions.

Tax Saving FD Interest Rates (5-Year Lock-In):

1. SBM Bank India: 7.75% (8.25% for senior citizens)
2. YES Bank: 7.25% (8.00% for senior citizens)
3. DCB Bank: 7.40% (7.90% for senior citizens)
4. IndusInd Bank: 7.25% (7.75% for senior citizens)
5. RBL Bank: 7.10% (7.60% for senior citizens)

The returns from tax-saving FDs are predictable but lower compared to ELSS. Senior citizens can benefit from slightly higher interest rates.

Which One Should You Choose?

The choice between ELSS and tax-saving FD depends entirely on your risk appetite and financial goals. Here’s a quick guide to help you decide:

• Choose ELSS If:

• You are comfortable with market fluctuations and can handle short-term volatility for long-term gains.
• You are aiming for higher returns and are ready to stay invested for at least 3 years.
• You are in a lower tax bracket and want to minimize the impact of taxes on your investment returns.
• Choose Tax Saving FD If:

• You prefer a guaranteed return without worrying about market risks.
• You are looking for a safe investment option with fixed returns and are fine with a 5-year lock-in.
• You fall in a higher tax bracket and don’t mind paying taxes on interest income.

Final Thought: ELSS for Growth, FD for Safety

Ultimately, both ELSS and tax-saving FDs have their advantages. If you are a risk-taker looking to grow your wealth, ELSS could provide the higher returns you’re after. However, if you want to ensure capital safety with fixed returns, tax-saving FDs are the safer bet.

Always assess your financial situation, risk tolerance, and long-term goals before choosing between the two options.