Equity Linked Savings Scheme (ELSS) funds are a popular choice among Indian investors looking at a blend of tax savings and potential wealth generation. As mutual funds that principally invest in equities, ELSS funds offer the dual benefit of earning higher returns while simultaneously providing tax deductions under Section 80C of the Income Tax Act. However, like all financial instruments, it’s imperative to understand all aspects before committing your hard-earned money. Here are the key things to know before investing in ELSS funds.
Understanding ELSS Funds
ELSS funds are equity mutual funds where a minimum of 80% of the assets are invested in equity and equity-related instruments. These funds come with a mandatory lock-in period, which is one of the key features that sets them apart from other mutual funds and tax-saving instruments.
Tax Benefits
One of the primary attractions of ELSS funds is the tax benefits they offer. Investments up to ₹1,50,000 in ELSS qualify for a deduction under Section 80C. This can potentially save you up to ₹46,800 in taxes annually if you fall under the 30% tax bracket, assuming you utilize the full ₹1,50,000 limit.
Lock-In Period
A crucial aspect of ELSS funds is the lock-in period of three years. This means your investment cannot be redeemed before three years from the date of allotment. This period is shorter compared to other tax-saving instruments like Public Provident Fund (PPF), which has a lock-in period of 15 years, or National Savings Certificate (NSC), which has a five-year lock-in period. The lock-in period, however, also implies that you should be prepared for market volatility and should not rely on these funds for short-term financial needs.
Performance and Returns
The returns from ELSS funds are market-linked, as these funds predominantly invest in stocks. Historical returns from ELSS funds have been in the range of 12-15% over a longer duration, which is higher compared to other tax-saving instruments like PPF or FDs. However, past performance is not an indicator of future success. It’s crucial to review the fund’s performance on various parameters such as consistency, risk ratio, and fund manager’s credibility.
Investment Horizon
While the minimum lock-in period is three years, it is generally advised to stay invested for a longer duration to reap the full benefits of equity investments. By staying invested, investors can mitigate short-term market volatility and benefit from the compounding effect, potentially resulting in substantial wealth accumulation over time.
SIP vs Lump Sum
Investors have the flexibility to invest in ELSS through Systematic Investment Plans (SIPs) or lump-sum modes. SIP allows you to invest a fixed amount regularly (monthly, quarterly, etc.), which helps in averaging the purchase cost and mitigating the impact of market volatility. On the other hand, lump-sum investments might be suitable if you have a significant amount available and wish to allocate it at once. However, each SIP installment will be locked in for three years from its respective date of investment.
Capital Gains Tax
The returns from ELSS funds are subject to Long Term Capital Gains (LTCG) tax. Gains up to ₹1,00,000 in a financial year are tax-free, but gains exceeding this threshold attract a 10% tax. Dividends from these funds are also governed by similar tax laws under the newer tax regime.
Risk Factors
Investing in ELSS funds comes with its share of risks, primarily due to the volatility associated with equity investments. Market downturns can lead to potential short-term losses. Hence, investors must assess their risk tolerance and investment horizon before choosing ELSS funds.
Diversification
ELSS funds offer the benefit of diversification as they invest across sectors and companies, depending on the fund manager’s discretion. This diversification helps in balancing the risk and aiming for optimal returns. It’s prudent to look into the portfolio mix of the ELSS fund to ensure it aligns with your risk appetite and investment goals.
Expense Ratio
The expense ratio represents the annual fee that the fund houses charge to manage the investments. A lower expense ratio means a higher take-home return for the investor. It is imperative to compare the expense ratios of multiple ELSS funds before making your investment decision.
Fund House Reputation
Investors should evaluate the credibility and track record of the fund house managing the ELSS. Renowned fund houses with a history of consistent performance tend to have better risk management frameworks and more experienced fund managers.
