Factors to Consider Before Investing in ELSS

Factors to Consider Before Investing in ELSS

ELSS stands for Equity Linked Savings Scheme which is a mutual fund eligible for tax exemption under Section 80C of the Income Tax Act, 1961. ELSS is an equity-dominated fund that comes with a 3-year lock-in period. They are more popularly known as tax-saving mutual funds and are directly linked to the stock market’s performance.

Equity Linked Saving Scheme – Meaning

Like all mutual funds, ELSS is a pooled investment that invests in money market instruments. It allocates its major corpus of around 65%-80% to equities and equity-related instruments. The rest of the investible corpus is allocated to debt, gold, etc. ELSS is a kind of fund that has the tax benefits under Section 80C of the Income Tax Act, 1961 which offers a tax rebate of up to Rs. 1.5 Lakh on investment, annually. Some of the key points about ELSS to bear in mind are as follows:

  • The portfolio is equity-oriented and hence, it is a high-risk investment. Around 65-80% of the corpus invested in stocks is invested across all capitalizations, sectors, and themes to have a balanced and diverse portfolio
  • This fund qualifies for tax exemption under Section 80C provision which means that investors have a tax rebate of up to Rs. 1,50,000 in a year. By investing in ELSS, one can save up to Rs. 46,800
  • The fund also has a lock-in tenure of 3 years where the premature exit is not applicable. Also, among all tax saver plans which usually have a minimum lock-in time of 5 years, ELSS has the shortest duration. But, there is no maximum tenure for the fund and hence, one can invest as long as they want
  • Investors can invest in ELSS periodically through a SIP (Systematic Investment Plan) or a lump sum in a year. The minimum amount in both cases may vary according to the fundhouse/AMC (Asset Management Company); however, there is no upper cap on the maximum amount one can invest

Factors to Consider before Investing

1. Lump-Sum vs SIP

We reiterate that SIPs have major advantages like investors can invest small amounts that are light on the pocket as well as have the benefit of Rupee Cost Averaging (RCA). SIPs allow you to invest throughout the business cycle where the markets go through ups and downs. When markets are bearish, you can purchase more units of the fund as the NAV is low. When markets are expensive and bullish, you buy lesser units with the same installment amount of the SIP. In the long run, the cost of units is averaged out.

When invested through a lump sum, you need time to invest when the markets are low but it also involves high risk. If you invest a lump sum during a bull market, the fund units are really expensive. So, it is not advisable to invest a lump sum in ELSS but rather invest via SIP. Many investors invest in ELSS in a rush to save taxes at the last moment and end up investing a lump sum without much focus on the market trend. You can plan better at the start of the financial year by investing through SIPs than a lump sum at the end. This will help to save taxes along with the investments at averaged costs.

2. Growth & Dividend Options

As an investor, you can opt for either growth or dividend options. In the latter, you can receive regular income through dividend payouts for as many years as you invest in ELSS. If you go for the growth option, there is no dividend benefit as they are reinvested in the fund to buy you more units and let the capital grow. The NAV of the units increases when dividends are reinvested and it helps in multiplying the profits to the investor especially when markets are good.

3. Taxation

As the units can be redeemed only after a 3 year lock-in time, the capital gains are considered Long Term Capital Gains (LTCG) and are taxed like one. LTCG from equity funds is tax-exempt up to Rs. 1,00,000 and above this limit, they are taxed at 10%. So, the investors have dual benefits that the ELSS is tax-exempt up to Rs. 1.5 Lakh yearly as long as you stay invested and upon redemption, it is exempt from taxation up to Rs. 1 Lakh.

Benefits of ELSS

As mentioned above, ELSS is a fund that comes with the benefits of taxation which can be coupled with other advantages of the fund such as follows:

  • Being an equity fund, these funds have the potential to give exponential returns which makes them a perfect combination of wealth-creation and tax-saving tool
  • Although the portfolio is dominated by stocks and equity-related instruments, there is some exposure to debt, bonds, and fixed income securities. Among equities, the investment is spread across companies of all capital sizes and sectors. This provides diversity, balance, and security to the fund
  • Other than its 3-year lock-in, having an investment horizon of a minimum of 5 years can help investors reap better results. It is because a longer duration can mitigate market volatility to give inflation-beating returns
  • If invested through SIP, ELSS has a low minimum cost as investors need to accumulate a reasonable amount of money but can invest through small periodic amounts. Moreover, SIP offers the power of compounding to the capital growth and the Rupee Cost Averaging (total costs of units are averaged out)
  • It offers dual benefits of tax saving and corpus building with almost double the returns and lowest lock-in period than other tax saver schemes under Section 80C

Risks of ELSS

All mutual funds are subject to market risks, especially equity funds and so is ELSS. These funds do not offer guaranteed returns as they are high-risk-return investments investing in market-linked instruments and depending on the performance of underlying securities. However, if invested for the long term, they can beat market instability to offer good returns to the investors.

Wrapping up:

ELSS is an equity mutual fund that offers twin benefits of corpus accumulation and tax savings. Investors who want to reduce their tax liability along with high capital growth should invest in ELSS. It is also tax-efficient and has the lowest lock-in tenure among all tax-saver schemes under Section 80C, with the highest return-giving potential. Investors must have a high-risk tolerance to invest in ELSS as these funds are mainly focused on equity-related instruments that are highly market volatile. However, it is in the safe hands of experts/fund managers as they are professionally managed, and investing via SIP helps to benefit from all market cycles. So, if you want exponential growth, regular returns, and tax savings, go for ELSS and invest through SIP to get the benefit of averaged costs, compounded growth, and lower investment threshold.

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