A Guide To Elss Investments In India

Investing in Equity Linked Savings Schemes (ELSS) is a smart way to grow your wealth while enjoying tax benefits in India. ELSS funds are a category of mutual funds that combine the potential for high returns with tax savings under Section 80C of the Income Tax Act, 1961.

ELSS funds are equity funds that invest a major portion of their corpus into equity or equity-related instruments. They are also called tax-saving schemes since they offer tax exemption of up to Rs. 1,50,000 from your annual taxable income. ELSS funds have a lock-in period of three years, promoting long-term wealth creation while reducing tax liabilities.

The simplest method to invest in ELSS funds is by using an Online Investment Services Account. You have the option to invest a lump sum or through a Systematic Investment Plan (SIP). Tax benefits are limited to INR 1.5 lakh, but you can invest any amount you wish.

Tax benefits of ELSS funds

Equity Linked Savings Schemes (ELSS) are tax-saving investment instruments in India. ELSS funds are classified as diversified equity mutual funds, with a minimum of 80% of the total investible corpus invested in equity and equity-related instruments.

Tax Deduction under Section 80C:

ELSS investments are eligible for a tax deduction under Section 80C of the Income Tax Act, 1961. This allows investors to claim a deduction of up to Rs. 1.5 lakh on their annual taxable income, resulting in potential tax savings of up to Rs. 46,800 per year.

Long-Term Capital Gains (LTCG) Tax Exemption:

ELSS funds have a mandatory lock-in period of three years, after which investors can redeem their investments. The first Rs. 1 lakh of LTCG from ELSS is tax-free, while gains exceeding this limit are subject to a 10% tax.

Dual Benefits of Tax Savings and Wealth Creation:

ELSS funds offer the dual advantage of tax deductions and wealth accumulation over time. The potential for high returns, coupled with tax benefits, makes ELSS an attractive option for long-term investors.

Shortest Lock-in Period:

Compared to other tax-saving instruments like Public Provident Fund (PPF) and National Savings Certificate (NSC), ELSS has the shortest lock-in period of just three years, providing more liquidity to investors.

Diversification and Risk Mitigation:

ELSS funds invest in a diversified portfolio of equity stocks across different sectors and market capitalizations, reducing concentration risks. This diversification helps to mitigate overall investment risk by spreading it across various assets.

Systematic Investment Plans (SIPs):

Investors can opt for SIPs, which allow them to invest a fixed amount at regular intervals. SIPs encourage disciplined investing, provide the benefit of rupee cost averaging, and make it easier to invest without requiring a large lump sum at the end of the fiscal year.

No Maximum Investment Limit:

While the tax benefits under Section 80C are limited to Rs. 1.5 lakh, there is no upper limit on the total amount that can be invested in ELSS funds. Investors can invest more than Rs. 1.5 lakh but will not receive additional tax benefits on the excess amount.

In summary, ELSS funds offer a range of tax benefits, including tax deductions, LTCG tax exemptions, wealth creation potential, and a short lock-in period. These advantages make ELSS funds a popular choice for investors seeking to optimize their tax liabilities while growing their wealth.

ELSS funds' lock-in period

ELSS funds have a lock-in period of three years, which is shorter than that of other tax-saving options under Section 80C of the Income Tax Act, such as fixed deposits (five years), the Public Provident Fund (PPF) (15 years), and the National Pension Scheme (NPS) (until the investor turns 60). This lock-in period encourages investors to adopt a long-term investment horizon, promoting wealth creation and financial discipline.

The lock-in period starts from the date of investment, and during this time, no redemption of units or withdrawal of the invested amount is allowed. After the lock-in period ends, investors can choose to withdraw their assets from ELSS funds or continue investing. For SIP investments, each instalment has its own three-year lock-in period starting from its respective investment date.

The three-year lock-in period offers several benefits, including:

• Encouraging patience and a long-term investment horizon, which can potentially lead to higher returns.
• Creating wealth by investing in equities, which tend to perform better over the long term.
• Providing tax benefits under Section 80C of the Income Tax Act, with investments of up to Rs. 1.5 lakh in ELSS funds eligible for a deduction.
• Skirting volatility by preventing investors from making impulsive trading decisions based on short-term market fluctuations.

How to choose an ELSS fund

When choosing an ELSS fund, there are several factors to consider. Here are some essential things to keep in mind:

• Lock-in period: ELSS funds have a mandatory lock-in period of three years. This means you cannot redeem or transfer your investment during this time. It's important to consider this restriction and ensure it aligns with your investment goals and horizon.
• Tax benefits: ELSS funds offer tax benefits under Section 80C of the Income Tax Act, 1961. You can claim a tax rebate of up to Rs. 1,50,000, resulting in potential tax savings of up to Rs. 46,800 per year.
• Investment modes: You can invest in ELSS funds through Systematic Investment Plans (SIPs) or lump-sum investments. SIPs allow you to invest at regular intervals, while lump-sum is a one-time investment.
• Risk factors: ELSS funds are subject to liquidity and market risk. Liquidity risk refers to the possibility that you may not be able to redeem your investment without incurring a loss. Market risk is the potential for losses due to market downturns, economic conditions, and other factors.
• Diversification: ELSS funds invest primarily in equities, with a minimum of 80% of their assets allocated to equity and equity-related instruments. This diversification across market capitalizations and sectors helps to balance risk and enhance return potential.
• Performance and returns: Consider the historical performance and returns of the ELSS fund. Look for consistent returns over time and compare the annualised returns of different funds to make an informed decision.
• Investment objectives: Choose an ELSS fund that aligns with your financial goals and risk appetite. Consider your investment horizon and the level of risk you are comfortable with.
• Fund size and ratings: Evaluate the size and rating of the ELSS fund. A larger fund size may indicate a more established and reliable fund, while ratings can provide insights into the fund's performance and risk profile.
• Expense ratio and fund management: Consider the expense ratio, which represents the fund's operating expenses as a percentage of its assets. A lower expense ratio means more of your money is invested in the market. Also, look into the fund management team's experience and track record.
• Exit load: Some ELSS funds may charge an exit load, which is a fee for withdrawing your investment before a certain period. Be sure to review the fund's exit load policy before investing.

Remember, it's essential to carefully consider your financial situation, goals, and risk tolerance before investing in any ELSS fund. Conduct thorough research, compare different funds, and seek expert advice if needed to make an informed decision.

How to invest in an ELSS fund

Equity Linked Savings Schemes (ELSS) are a category of mutual funds that combine the potential for high returns with tax savings under Section 80C of the Income Tax Act. ELSS funds primarily invest in equities and equity-related instruments, making them ideal for tax-saving and wealth-building. Here is a step-by-step guide on how to invest in an ELSS fund:

Step 1: Choose a Fund

Select an ELSS fund that aligns with your financial goals and risk tolerance. Consider factors such as the fund's performance, expense ratio, and the fund manager's track record.

Step 2: Complete the KYC Process

Finish the Know Your Customer (KYC) formalities with a registered mutual fund distributor or through an online platform recognised by the mutual fund industry.

Step 3: Fund Selection

Once your KYC is completed, choose the specific ELSS fund in which you want to invest based on your research and investment strategy.

Step 4: Determine the Investment Amount and Payment Method

Decide on the amount you wish to invest in the ELSS fund. You can choose between investing a lump sum or setting up a Systematic Investment Plan (SIP). With SIP, you can invest a fixed amount at regular intervals, helping you inculcate a habit of regular saving and investing.

Step 5: Submit Documents

Provide the necessary documents, such as your PAN card and Aadhar card, to comply with regulatory requirements.

Step 6: Fill Out the Fund Application

Fill out the application form for the chosen ELSS fund, ensuring accuracy and completeness of the information provided.

Step 7: Make the Payment

Transfer the desired investment amount through a bank transfer or online payment method as per the instructions provided by the mutual fund.

Step 8: Understand the Lock-in Period

ELSS investments come with a mandatory lock-in period of three years, promoting long-term wealth creation while reducing tax liabilities. This means you cannot withdraw your money from the ELSS fund before the completion of the lock-in period.

Step 9: Monitor Your Investments

Keep track of your ELSS investments, reviewing them periodically to ensure they align with your financial goals.

Step 10: Decide to Redeem or Stay Invested

After the lock-in period ends, evaluate the performance of your investment and decide whether to redeem your investment or continue investing based on your financial objectives and market conditions.

Benefits of Investing in ELSS Funds:

• Tax Savings: ELSS investments offer tax deductions of up to Rs. 1.5 lakhs per annum under Section 80C of the Income Tax Act.
• Equity Exposure: ELSS funds invest at least 80% of their assets in equity and equity-related instruments, offering the potential for higher returns over the long term.
• Short Lock-in Period: With a lock-in period of just three years, ELSS funds offer more flexibility compared to other investment options like NSC and PPF, which have longer lock-in periods.
• Diversification: ELSS funds invest in a diversified portfolio of equity stocks across different sectors and market capitalizations, helping to reduce risk.
• Liquidity: ELSS funds are open-ended schemes, allowing investors to redeem their units after the completion of the lock-in period.
• Low Minimum Investment: Most ELSS schemes have a low minimum investment requirement, starting as low as Rs. 500, making it accessible for those with lower taxable incomes or new investors.

Risks to Consider:

• Market Risk: ELSS funds invest predominantly in equities, making them susceptible to market fluctuations and volatility.
• Liquidity Risk: Due to the three-year lock-in period, investors cannot redeem or transfer their ELSS investments during this time, impacting their ability to liquidate their investments when needed.

Risks of investing in ELSS funds

Investing in ELSS funds carries a certain amount of risk. Here are some of the risks associated with investing in ELSS funds:

Liquidity Risk

ELSS funds are subject to a lock-in period of 3 years, during which the investor cannot redeem or transfer their investment. This may result in liquidity risk, as investors may be unable to access their money without incurring a loss in value.

Market Risk

ELSS funds are required to hold at least 80% of their portfolio in equity instruments, making them vulnerable to market risk. Poor market performance due to factors such as recession, political factors, or market sentiment can lead to losses for investors.

Performance Risk

The performance of an ELSS fund depends on the competence and judgment of the fund manager. A lapse in judgment by the fund manager can negatively impact the scheme's portfolio, resulting in losses for investors.

Higher Exposure to Equity

ELSS funds are diversified equity-oriented investments, which carry more risk than debt-oriented investments. Equity is considered a risky asset class exposed to volatility and market fluctuations. While ELSS funds have the potential to generate high returns, these returns come with an element of risk.

No Guaranteed Returns

ELSS funds do not provide guaranteed returns. The returns are fully contingent on the performance of the underlying securities. While a longer investment horizon can yield larger returns, there is no assurance of achieving the desired investment objectives or target returns.

Short-Term Risk

ELSS funds carry higher short-term risk due to the volatility involved in equity investments. However, the risk is much lower for investments held for more than five years.

Frequently asked questions