ELSS Tax Benefit: Benefits of Investing in Equity-Linked Saving Schemes (ELSS)
Benefits of Investing in Equity-Linked Saving Schemes (ELSS)
Equity Linked Savings Schemes (ELSS) stand out for offering a smart way to grow your money while saving on taxes. These funds invest mainly in stocks, which means they can provide higher returns compared to traditional tax saving options. Plus, they have a shorter lock-in period under Section 80C, making them flexible and appealing for those looking to balance risk and reward. Read on to learn how ELSS mutual funds work and why they could be a valuable part of your investment plan.
How Do ELSS Mutual Funds Work?
An ELSS mutual fund operates like any other mutual fund, pooling resources from multiple investors to invest in a diversified portfolio of stocks. However, what sets it apart is its classification as an ELSS, designed to offer the dual benefits of capital appreciation and tax deductions. These funds are primarily equity based, with at least 80% of their assets invested in equities. This exposure to the equity market provides the potential for higher returns over the long term, though these funds also come with their own set of risks.
Here some of the key benefits of ELSS:
Tax Benefit Under Section 80C
The tax-saving nature of ELSS funds makes it a preferred investment tool. The investments made in ELSS are eligible for a tax deduction of up to ₹1.5 lakh. You can claim deductions under Section 80C of the Income Tax Act. This unique blend of equity and tax-saving mechanism has made it popular among new and experienced investors alike.
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Shortest Lock-in Period
Almost every major tax-saving instrument comes with a mandatory lock-in period, from Public Provident Fund (PPF), National Savings Scheme (NSC), to traditional bank fixed deposits (FDs). This is also the case with ELSS. While PPF has the longest period of 15 years, NSC and bank FDs are set for a minimum period of five years. In comparison, ELSS has the shortest lock-in period of just three years. This mandatory lock-in helps beginners to withstand the volatility of the stock market while giving the scheme enough time to multiply the returns.
Higher Returns
In ELSS, a major part of the financial corpus is invested in equity. You can expect a much higher return than any other traditional tax-saver. Being a market-linked investment scheme, an ELSS fund has the potential to provide a return between 15%–18%. Of course, equity-based investments do carry an element of risk. However, the lock-in makes it easy to absorb the loss and continue growing throughout the tenure.
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Long-term Capital Gains (LTCG):
As ELSS is an equity scheme, it attracts a Long-Term Capital Gains (LTCG) tax of 10% on the profits received. This is applied when the amount crosses the threshold of ₹1 lakh per year. Despite that, it is still a tax-saving scheme. So, you can always claim deductions under the specified Income Tax act.
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Different Ways To Invest:
Like any other mutual fund investment, an ELSS also has different modes of investment. You can choose to invest in a lump sum or at regular intervals. Alternatively, you may go for a systematic investment plan (SIP). ELSS investment through the SIP mode means depositing a fixed amount at regular intervals.
The SIP method offers the advantage of rupee cost averaging, which involves investing a fixed amount at regular intervals, regardless of market conditions. This strategy can help mitigate the impact of market volatility and enable disciplined investment. Furthermore, it allows investors to start with a relatively small amount, making ELSS funds accessible to a broader audience.
However, if an SIP is your preferred mode of investment, keep in mind that each SIP instalment in ELSS will have a lock-in of three years. You can continue to invest in an ELSS as an open-ended scheme once the lock-in is over.
Here's How ELSS Compares Against Other Tax Saving Instruments
When it comes to tax-saving options, ELSS funds often stand out for several reasons. First and foremost, they provide the shortest lock-in period of three years compared to other options like public provident funds (PPF) and tax-saving fixed deposits, which typically require a minimum commitment of five years. Additionally, the potential for higher returns due to equity exposure gives them an edge over traditional debt-based instruments. However, it is essential to consider the associated risks, as equity investments can be volatile. In terms of tax benefits, investments in ELSS qualify for deductions under Section 80C of the Income Tax Act, allowing investors to claim up to ₹1.5 lakh in deductions annually.
Who Should Invest in ELSS?
ELSS funds are particularly suitable for individuals who are willing to take on some level of risk in exchange for potentially higher returns. Young investors or those with a higher risk appetite may find these funds to be an excellent choice due to their equity focus. Moreover, those who are planning for long-term financial goals, such as retirement or children's education, can benefit from the growth potential of ELSS schemes. It is also a viable option for salaried individuals looking to optimise their tax savings while simultaneously building wealth. However, it is crucial to align investment choices with your risk tolerance and financial objectives.
Things to Consider Before Investing in ELSS
Before diving into investing in ELSS, there are several factors to ponder. First, assess your risk appetite, as ELSS funds are primarily equity-oriented and can exhibit significant short-term fluctuations. It is crucial to have a long-term perspective to ride out market volatility. Second, evaluate the fund's historical performance, though it is important to remember that past performance does not guarantee future results. Third, consider the fund manager's expertise and the asset management company's reputation. Finally, ensure that your investment aligns with your overall financial plan and goals.
Summing Up
With the lowest lock-in period, SIP option, and superior returns, ELSS is possibly the best option you can get under Section 80C. Though it attracts LTCG, it is still one of the best tax-saving instruments. The results could be even better if you stretch the tenure for at least two more years.
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