If you are looking for a great tax investment that also provides an opportunity for wealth building and has the shortest lock-in period, ELSS is what you need. ELSS or Equity-Linked Saving Scheme is a type of equity mutual fund that invests primarily in equity and equity-linked securities.
They are eligible for deductions under Section 80C of the Indian Income Tax Act 1961 and come with a mandatory lock-up period of 3 years.
ELSS funds are diversified equity funds, which invest in listed stocks in specific proportions, depending on the investment objective of the fund. These stocks can be chosen based on industry sectors or market capitalization, such as large, mid, and small caps.
The fund manager chooses them on the basis of in-depth market research, in order to offer optimal risk-adjusted portfolio returns. The objective here is long-term capital appreciation.
Characteristics of the ELSS
ELSS funds can be open-ended or closed-end. In an open-ended plan, you can invest in an ELSS fund at any time. Mandatory blocking period applies. However, after it ends, redemptions can be made at any time.
However, in any closed ELSS system, investments only take place during the NFO (New Funds Offer) period. After that, investments are not allowed. Once the lock-up period has ended and the plans have matured, you can only liquidate the investment at a specific time as declared by the fund.
If you want to receive a regular income, you can opt for the payment of dividends. Or, you can opt for the growth option for long-term capital appreciation. Being an equity-linked investment, your potential return could be higher over longer periods. However, it is a market-linked product, which means that there are market risks associated with investing.
When you sell stocks and stock-related investments, after a holding period of one year or more, you will have to pay a 10% LTCG (long-term capital gains) tax. This is applicable on capital gains of more than Rs 1 lakh, without the benefit of indexation. LTCG up to Rs1 lakh is tax exempt.
If you opt for the dividend option during the lock-in period, this amount will be added to your taxable income and taxed according to your tax bracket.
There is no upper limit to the amount you can invest in an ELSS fund. However, the minimum investable amount tends to differ from fund to fund.
Benefits of Investing in ELSS
Despite the risks associated with investing in stocks, this type of mutual fund offers multiple advantages that make it an attractive option. Some of the main benefits include:
Double benefit of capital appreciation and tax saving: Investments in ELSS provide tax deductibility of up to Rs 1.50,000 in a financial year, under Section 80C (as well as other eligible instruments). ELSS saves up to Rs 46,800 per annum, in taxes within the 30% tax bracket.
It is also an opportunity to create a corpus. This is different from other 80C investments, such as PPFs or FDs, which are fixed income instruments. ELSS is market-linked and has the potential for higher returns over the medium to long term.
Thus, it has the potential to generate better anti-inflation returns, compared to other investments.
ELSS has the shortest lock-up period among all 80C investments. Tax-saving FDs have a lifespan of 5 years, while PPFs have a lifespan of 15 years. Other investment options, such as ULIPs, usually come with a lock-up period of 5 years. A 3-year lock-in period is actually a blessing in disguise, as it strongly embeds a good habit of staying invested for a longer period of time, limiting investors from taking action due to short-term corrections.
It is easy to invest in such funds through monthly SIPs or systematic investment plans.
This brings investment discipline and consistency while eliminating risk to capital. It also allows you to take advantage of Rupee cost averaging in an automated way.
This means that you regularly invest a fixed amount and reduce the “timing” aspect, regardless of the level of the market. You end up buying more investment units when prices are up, and less when prices are up.
Professional fund managers invest your money in a planned and systematic way to maximize your returns. However, since these funds are exposed to equities, there are risks. At the same time, since they invest in multiple stocks at once, the risk can be mitigated to some extent.
You can invest in ELSS through flat rate mode or SIP mode. The lump sum mode is advantageous if you have capital on hand. The SIP route can be useful if you’re a newbie investor, don’t have the expertise to follow the markets, or don’t have access to a lump sum to commit all at once.
An online investment services account can be opened, where you regularly deposit a fixed sum of money. You can start your investment in an ELSS fund with as little as Rs 1,000.
You can also invest in these funds offline, by submitting an application to the fund office or the AMC office. ELSS funds have no entry and exit charges, but you will have to pay management fees.
ELSS funds could be a good investment vehicle for novices, who also want to reduce their tax burden.
(The author is Head of Retail Research, HDFC Securities)
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