Everything you need to know about ELSS

Investing can be a rewarding yet challenging venture, particularly in an economy as diversified and growing as India's. One investment option that frequently sticks out when it comes to reducing taxes and increasing wealth is Equity-Linked Savings Schemes (ELSS). The goal of this blog is to help you understand ELSS so that you may comprehend it better and think about including it in your investing portfolio. Regardless of your level of experience, this guide will give you insightful knowledge about the ELSS.

What is ELSS?

Equity-Linked Savings Schemes, commonly known as ELSS, are a type of mutual fund investment through which you can primarily invest in the stock market. ELSS offers the dual benefits of capital appreciation and tax savings. A distinguishing feature of ELSS funds is their lock-in period, which is currently for three years. This means that the investment made in an ELSS fund cannot be withdrawn before the completion of three years from the date of investment.

What are the Features of ELSS Funds?

ELSS funds have several key features that make them an attractive investment option for many:

• Tax Benefits: As mentioned earlier, investments in ELSS are eligible for tax deductions under Section 80C of the Income Tax Act, with an upper limit of ₹1.5 lakh per financial year.

• Lock-in Period: ELSS funds come with a minimum lock-in period of three years, which is shorter compared to other tax-saving options like PPF or NSC.

• Equity Exposure: These funds predominantly invest in equity and equity-related instruments, which often leads to higher returns over the long term compared to traditional fixed-income investments.

• Diversification: ELSS funds provide diversification as the fund manager invests in a variety of stocks across different sectors and market capitalisations.

• Potential for Higher Returns: Due to their equity component, ELSS funds have the potential to deliver higher returns compared to other fixed-income tax-saving options, especially over a longer investment horizon.

• SIP Option: Investors can choose to invest in ELSS funds through a lump sum or a systematic investment plan (SIP), which allows for investing small amounts regularly.

• Ease of Investment: Investing in ELSS is straightforward and can be done online, making it convenient for investors.

Factors to Consider Before Investing in ELSS Funds

Before diving into ELSS funds, consider these factors:

• Risk Appetite: Assess your risk tolerance as ELSS funds are linked to the stock market and can be volatile in the short term.

• Investment Horizon: Ideally, consider ELSS if you have a long-term investment horizon, as equity investments tend to perform better over longer periods.

• Financial Goals: Align your investment in ELSS with your financial goals. ELSS can be a great tool for achieving long-term goals like retirement planning or buying a house.

• Past Performance: While past performance is not indicative of future results, understanding it can provide insights into the fund manager's expertise and the fund's consistency.

• Expense Ratio: Look at the fund's expense ratio as it affects the overall returns. A lower expense ratio is generally preferable.

• Fund Manager's Track Record: The fund manager’s experience and track record in managing funds, especially during market downturns, is an important consideration.

• Diversification in Portfolio: Ensure that your investment in ELSS complements your overall investment portfolio in terms of asset allocation and diversification.

Remember, while ELSS offers tax benefits and the potential for high returns, it's crucial to understand your financial situation and consult with a financial advisor if necessary.

What are the Tax Saving Benefits of ELSS?

ELSS funds are particularly popular for their tax-saving benefits under Section 80C of the Indian Income Tax Act. Here's how you can benefit:

• Deduction Under Section 80C: Investments made in ELSS are eligible for a tax deduction. You can claim up to ₹1.5 lakh per financial year as a deduction from your gross total income.

• Lower Lock-in Period: Compared to other tax-saving options under Section 80C, like PPF or 5-year fixed deposits, ELSS has a relatively shorter lock-in period of three years.

• Tax-Efficient Returns: The returns from ELSS funds, after the lock-in period, are subject to Long Term Capital Gains (LTCG) tax. As per the latest guidelines, gains exceeding ₹1 lakh in a financial year are taxed at 10% without indexation benefit. This is generally more tax-efficient compared to interest income from fixed-income investments, which are taxed as per your income tax slab.

• Benefit of Indexation: Although LTCG on ELSS is taxed, the tax impact is often mitigated by the higher potential returns provided by equity investments.

• Dividend Income: If the ELSS option chosen is a dividend plan, the dividend income is tax-free in the hands of the investor. However, the fund house pays a Dividend Distribution Tax (DDT) before distributing the dividend.

Should You Invest in a SIP or in a Lump Sum?

Choosing between SIP (Systematic Investment Plan) and lump sum investment in ELSS depends on your financial situation and investment style:

SIP:

• Suitable for Regular Investors: If you're a salaried individual looking to invest regularly, SIPs can be an ideal choice. They allow you to invest a fixed amount regularly, say monthly, in ELSS funds.
• Rupee Cost Averaging: SIPs help in averaging the purchase cost of fund units over time, reducing the risk of market timing.
• Financial Discipline: Regular investments through SIPs instill financial discipline.

Lump Sum:

• Suitable for Large Investments: If you have a substantial amount to invest at once, a lump sum can be a good option.
• Market Timing: With lump sum investments, understanding the market becomes more crucial. It's generally suitable if you understand market cycles or invest during market lows.
• Ideal for Short Investment Windows: If you're investing towards the end of the financial year for tax-saving purposes, a lump sum might be more feasible.

Both methods have their merits, and the choice often depends on to your cash flow situation, investment strategy, and risk tolerance.

How to Invest in ELSS?

Investing in ELSS is a straightforward process, and you can do it either offline or online. Here’s how:

• Choose the Right Fund: Research and select an ELSS fund that aligns with your investment goals and risk appetite. Consider factors like the fund’s past performance, the fund manager's track record, expense ratio, and investment philosophy.

• KYC Compliance: Ensure that your Know Your Customer (KYC) formalities are completed. This involves providing identity and address proofs, and a photograph. KYC is a mandatory requirement for all mutual fund investments in India.

• Investing Online: Most mutual fund companies and financial platforms offer online facilities to invest in ELSS. You can visit the official website of the mutual fund or use a trusted investment platform to start investing.

• Investing Offline: If you prefer the traditional method, you can visit the nearest branch of the mutual fund or a financial advisor, fill out the application form, and submit the required documents.

• Choose Investment Mode: Decide whether you want to invest through a Systematic Investment Plan (SIP) or a lump sum investment.

• Monitor Your Investment: Once invested, it’s important to monitor the performance of your ELSS fund periodically to ensure it aligns with your financial goals.

Conclusion

Equity-Linked Savings Schemes (ELSS) offer a compelling mix of tax savings and the potential for high returns, making them a preferred choice for many investors in India. While they come with a set of risks due to their equity exposure, the long-term growth prospects can be significant. Remember, choosing the right fund and investing as per your financial goals and risk tolerance is key. Platforms like InsuranceDekho can simplify this process, providing valuable guidance and tools for effective investment. 

FAQs

• What is an Equity-Linked Savings Scheme (ELSS)?

ELSS is a type of mutual fund that primarily invests in the stock market, offering tax benefits under Section 80C of the Income Tax Act in India. These funds have a lock-in period of three years.

• How does ELSS offer tax benefits?

Investments in ELSS are eligible for a tax deduction of up to ₹1.5 lakh per financial year under Section 80C. The long-term capital gains from ELSS are taxed at 10% for gains exceeding ₹1 lakh in a financial year.

• What is the lock-in period for ELSS?

ELSS has a lock-in period of three years, which is the shortest among the tax-saving options available under Section 80C.

• Can I invest more than ₹1.5 lakh in ELSS?

Yes, you can invest more than ₹1.5 lakh in ELSS, but the tax deduction under Section 80C is capped at ₹1.5 lakh.

• Is it better to invest in ELSS through SIP or lump sum?

It depends on your financial situation. SIP is suitable for regular, disciplined investing, while lump sum investments might be suitable if you have a large amount to invest at once. SIPs help in averaging the purchase cost over time.

• Are returns from ELSS guaranteed?

No, returns from ELSS are not guaranteed as they are subject to market risks. The performance of ELSS funds depends on the equity market.

• Can I withdraw my investment in ELSS before three years?

No, investments in ELSS cannot be withdrawn before the completion of the three-year lock-in period.

• How do I choose the right ELSS fund?

Consider factors like the fund's past performance, expense ratio, the fund manager's track record, and how well it fits your investment goals and risk tolerance.

• Is ELSS suitable for short-term goals?

Given the three-year lock-in period and the nature of equity investments, ELSS is more suitable for long-term financial goals.

• What happens to ELSS investment after the lock-in period?

After the lock-in period, you can choose to redeem your units or continue with the investment. The amount, if redeemed, is subject to Long Term Capital Gains tax if the gains exceed ₹1 lakh.