An Equity Linked Savings Scheme, also known as ELSS, is a type of mutual fund scheme that primarily invests in equities and equity-related securities. Section 80C of the Income Tax Act allows for a tax deduction on ELSS mutual fund investments of up to Rs. 1.5 lakhs. The lock-in period for ELSS mutual funds is three years. For their investors, ELSS funds provide the dual benefits of capital appreciation and tax savings.
How Do ELSS Mutual Funds Work?
ELSS Funds are equity-diversified funds. The stocks are selected from across market capitalization (Large Caps, Mid Caps, Small Caps) and industry sectors. These funds seek to maximize long-term capital appreciation. To deliver the best risk-adjusted portfolio returns, the fund manager picks stocks after thorough market research. Individuals and HUFs can invest in ELSS mutual funds to save on taxes under section 80C.
There is a considerable amount of risk associated with ELSS mutual funds. This is due to the portfolio’s exposure to equities. Therefore, investors who understand the risk associated with the equity asset class are more suited for ELSS mutual funds. Investors should consider the long term while making ELSS investments. These tax-saving funds are managed by dedicated, qualified professionals.
Investors can diversify their portfolios with ELSS funds. ELSS funds have the shortest lock-in period of the options that are eligible for tax deductions under Section 80C of the Income Tax Act.
The Advantages of ELSS Mutual Funds
ELSS is considered a good investment option because it offers tax benefits. Under Section 80C of the Income Tax Act of 1961, investments up to Rs. 1.5 lakh per year in ELSS are eligible for a tax deduction. You can invest any amount in ELSS, as there is no upper limit for investment. However, investments over Rs. 1.5 lakh are not eligible for tax benefits.
Lump Sum or SIP
There are two ways to invest in ELSS. Investing with a SIP can be done on a monthly basis. With a SIP, you can invest as little as Rs. 500 each month in ELSS. Alternatively, if you have surplus funds, you can invest in ELSS with a single lump-sum payment.
The ELSS allocated funds are invested in equities and equity-related securities in order to generate profits. Equity instruments are riskier than debt, bonds, and other money market securities. Prior to investing in stocks, you should assess your risk tolerance. In the long run, equities offer better returns, but they can be volatile in the short term.
Compared to other tax-saving options like PPF or NPS, top ELSS funds may offer better returns. These high returns are a result of the risk that fund houses undertake by investing in equities. Some top ELSS funds also invest in mid-cap companies. These funds can generate higher returns compared to funds that primarily invest in large-cap companies. However, the risk associated with these funds is higher than with other funds.
ELSS mutual funds are managed by professional fund managers. Compared to other tax-saving schemes, the expert advice provided by these managers helps investors to achieve higher returns. Therefore, even an investor with limited or no market knowledge might get the best returns by investing in ELSS mutual funds.
Usually, all tax-saving investment products have a lock-in period. For instance, Tax Saving Fixed Deposits and National Savings Certificates (NSC) both have a 5-year lock-in period. The Public Provident Fund (PPF) has a lock-in period of 15 years.
Comparatively, the ELSS category has the shortest lock-in period, requiring a minimum holding period of 3 years before redemption. It means you can’t withdraw funds for three years. For instance, if you got 1000 units in an ELSS fund on January 1, 2021, you would have to wait for three years to redeem those 1000 units, i.e., on or after January 1, 2024.
Many investors are unclear about how SIPs, or Systematic Investment Plans, are handled under the ELSS category. When determining the 36-month holding period for SIPs, each transaction or installment must be treated separately.
Let’s understand the lock-in period of ELSS funds with the help of an example:
Let’s assume that you want to invest Rs. 50,000 in ELSS funds in 2021. As discussed earlier, there are two options available:
Method 1: Lumpsum Investment
Let’s say that on January 1, 2021, you invested Rs. 50,000 in an ELSS mutual fund. Let’s assume that your investment of Rs. 50,000 bought you 5000 units.
You now have a 3-year lock-in period for the 5000 units you purchased. You can redeem these 5000 units only after 3 years, i.e., on January 1, 2024, and can withdraw them at any time thereafter.
Method 2: Systematic Investment Plan (SIP)
Let’s say you decided to invest the same Rs. 50,000 in 5 instalments of Rs. 10,000 each.
- 1 April 2021: For Rs. 10,000, you purchased 1,000 units
- 1 May 2021: For Rs. 10,000, you purchased 800 units
- 1 June 2021: For Rs. 10,000, you purchased 1,100 units
- 1 July 2021: For Rs. 10,000, you purchased 1,200 units
- 1 August 2021: For Rs. 10,000, you purchased 900 units
5000 units in total were purchased.
Total investment – Rs. 50,000
When are these units eligible for withdrawal?
Each installment is treated as a separate investment (even if it was made through a SIP) and is subject to a 3-year lock-in period.
- Starting on April 1, 2024, only the first 1000 units will be eligible for withdrawal. The remaining 4,000 units cannot be redeemed because three years have not yet passed.
- Your second, third, and fourth installments become available after 3 years are completed for each – on May 1, 2024, June 1, 2024, and July 1, 2024, respectively.
- All 5000 units will be available for withdrawal on August 1, 2024.
Things to Consider Before Investing in ELSS Funds
It’s crucial to evaluate a mutual fund before making an investment. Below are a few pointers an investor can consider before investing in ELSS funds:
- Fund Performance: Investors should start by looking at the fund’s performance. Both the current and past performance of the fund must be considered while evaluating its performance. It is also important to check the consistency of the fund. Investors must compare the fund’s performance with its competitors and benchmark it to know if it has shown consistent performance in the past.
- History of Fund House: Investors must examine the fund house, its management, and its years of experience. It is advised to choose fund houses that have performed consistently over a long period of time.
- Expense ratio: The expense ratio shows how much of your investment goes towards managing the fund. Investors must ensure that the fund has a low expense ratio. The lower the expense ratio, the higher the return.
- Taxation: Investors should understand the tax implications of redeeming their investments in the short and long term.
- Financial Parameters: To analyze a fund’s performance, you can also consider several factors, including Standard Deviation, Sharpe Ratio, Alpha, and Beta.
- Fund Manager: Another factor to consider is the fund manager, as they play a crucial role in the management of your funds. The fund manager needs to be competent and experienced in selecting the best stocks for building a solid portfolio
The Disadvantages of ELSS Funds
- No Guaranteed Returns: As a market-linked product, ELSS returns are not guaranteed. Their performance is determined by several market-related factors. Investors cannot expect guaranteed returns from ELSS, unlike fixed-income products such as Public Provident Fund (PPF) and Bank Fixed Deposits.
- Lock-In Period: There is a 3-year lock-in period after investing in ELSS (whether in a lump sum or by SIP ). Investors who invest in Equity Linked Saving Scheme funds should know that they cannot opt out of ELSS mutual funds before the end of the lock-in period.
- Limited benefits: Investors can only avail of tax benefits up to Rs. 1.5 lakhs even if they invest a surplus amount. Even if an investor invests Rs. 10 lakhs, they will get a tax benefit of Rs. 1.5 lakhs only.
- Management Cost: Due to the fact that ELSS mutual funds are handled by professional fund managers, one must expect to pay a fee for their professional management.
Tax Benefits of ELSS Funds
Under section 80C of the Income Tax Act 1961, investments in Equity Linked Saving Scheme funds qualify for tax exemption. A 10% Long-Term Capital Gains Tax (LTCG) was introduced on equity funds in April 2018. In an income tax calculation, capital gains from ELSS get the same treatment as the rest of the equity instruments.
Long Term Capital Gains (LTCG) are subject to a tax of 10% if the gains exceed Rs. 1 lakh during the financial year, while Short Term Capital Gains (STCG) attract a tax of 15%. The minimum lock-in period for investments in the Equity Linked Saving Scheme funds is three years. Thus, any profits generated from the sale of the units will be considered long-term capital gains, or LTCG.
PPF vs. ELSS
Both ELSS and Public Provident Fund (PPF) are eligible for tax savings under Section 80C of the Income Tax Act of 1961 of up to INR 1.5 lakhs. Since Equity Linked Saving Scheme invests in equity, it has higher volatility and, hence, greater returns.
PPFs have lower volatility and returns than ELSS funds. Public Provident Fund (PPF) investment is low risk because it is backed by the Government of India. The lock-in term for ELSS is three years, while it is fifteen years for the Public Provident Fund.
If you need funds during the investment period, you can make a partial withdrawal from your PPF account. However, there are no partial withdrawals permitted for ELSS during the lock-in period. The minimal investment in PPF is Rs. 500 and the maximum is Rs. 1.5 lakhs for each financial year. There is no upper limit to investment with ELSS funds. With a SIP, you can invest as little as Rs. 500 each month in ELSS.
Frequently Asked Questions (FAQs)
How can I invest in ELSS using Kuvera?
Kuvera is the one-stop solution for all your investments and financial goals.
- Download the Kuvera app or visit the website.
- Create your account on Kuvera by completing the mandatory KYC procedure. Once it is completed, select the ‘Invest’ option on the homepage, after which you can select ‘Mutual Funds’ and ‘ELSS’.
- Go through the list of various ELSS schemes before you start investing.
Is it mandatory to stay invested or withdraw funds even after the expiry of the lock-in period?
No, it’s not mandatory to stay invested even after the time period of three years. ELSS funds have a lock-in period of 3 years. According to their risk profile, investors can stay invested in these funds for a longer period to get more benefits.
It is not necessary to redeem your investment after the lock-in period. ELSS investments can offer long-term capital appreciation in addition to tax savings. You can extend your investment for a few more years. You can assess the fund’s historical risk-adjusted returns for the last few years. It is also beneficial to compare its performance to other funds belonging to the same category.
Why is a lock-in period imposed on ELSS?
A lock-in period is imposed to make it mandatory for investors to gain more from equity investments and to maintain the stability of the fund.
Do I need to invest in a lump sum for an ELSS fund?
There are two options available: Lumpsum and SIP. Since ELSS funds have a 3-year lock-in period, lump-sum investments cannot be withdrawn until 3 years after the first investment. Each SIP payment is also subject to the lock-in period.
How do I redeem my ELSS before 3 years?
You cannot withdraw from your ELSS funds before the lock-in period.
How do I change my ELSS before 3 years?
You cannot redeem or switch your ELSS investment before 3 years.
Can I withdraw from ELSS funds after 3 years?
Yes. After three years, the total amount of a lump-sum investment can be withdrawn. In the case of SIP investments, however, each investment must meet the 3-year lock-in period criteria.
What are the advantages of investing in ELSS funds?
- According to Section 80C of the Income Tax Act, a total investment of up to Rs. 1.5 Lakh can be deducted from the taxable income. Although you can choose to invest more than Rs. 1.5 lakh in ELSS, the tax exemption is only available for investments up to that amount.
- The Equity Linked Saving Scheme invests in equities, which have a better chance of generating higher returns.
- Tax saving schemes only have a 3-year lock-in term. This is shorter when compared to other tax-saving options.
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