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Things to Know before Making Investments in ELSS funds
Equity Linked Savings Scheme or ELSS is an outstanding and well-known investment option in India. It is popular for its double advantages of wealth creation and tax savings. These types of mutual funds come with tax advantages along with the potential for major capital appreciation.
Such kinds of funds are designed especially to provide you with assistance in income tax savings while building wealth over the long term through equity investments. Read and find out about some of the most important factors to take in consideration before making investments in Equity Linked Savings Scheme or ELSS funds and making informed financial decisions.
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Things to Know before Making Investments in ELSS funds
In ELSS funds, 80% of fund’s assets are mandated to be invested at least by the fund manager in equity and equity related instruments. The rest can be directed towards money market instruments or fixed income instruments, based on the chosen strategy of the fund.
Fund managers also have the discretion to choose the kind of stocks that align with their risk tolerance and the objectives of the fund. For example, high-risk ELSS funds might benefit from greater small-cap stocks allocation. On the other hand, medium-risk ELSS funds could lay more focus on large-cap stocks.
Also read: Best Lump Sum Investment Equity Mutual Funds for 2024.
What is ELSS Lock-in Period?
A lock-in period is a common requirement for investments offering tax benefits under the Income Tax Act’s Section 80C. However, ELSS funds are unique due to their lock-in period which is comparatively short – only 3 years.
This indicates that you cannot draw out your investments from these funds before the 3-year period comes to an end. This lock-in duration also aims to let your investment grow over a period and take the advantage of compounding.
In order to help you understand in simple terms, PPF and other investments of Section 80C have a significantly longer lock-in period of 15 years.
ELSS funds, having the potential for market-linked returns and a short lock-in period, are a must for your investment portfolio where tax-savings is a focus.
Do Not Have Too Many ELSS funds in Your Investment Portfolio
It is often that investors wonder whether a single fund is sufficient or whether they need to take multiple options in consideration.
While taking tax-saving investments in consideration, investors often have tax benefits as their sole focus. They ignore the broader impact of their investments on their portfolio. Due to this reason, you might end up buying units from any scheme on offer from a different AMC (Asset Management Company) every year.
Some investors may even overlook factors such as other details about the scheme, or risk levels, while focusing on tax savings primarily.
Over a period, it could lead to a circumstance where there are multiple ELSS schemes in your investment portfolio. If you do not plan carefully, it might lead to an accumulation of too many ELSS funds in the same category.
Lump-Sum Vs SIP: Which One Should You Go For?
For investors, there are many benefits to be obtained from SIPs. You can make investments in budget-friendly and smaller amounts and also benefit from RCA (Rupee Cost Averaging). With SIPs, you can get the flexibility to make consistent investments – even in fluctuating market conditions.
In a bearish market, more fund units can be acquired due to the lower NAV (Net Asset Value). In a bullish market, where prices are higher, fewer units will be purchased by your SIP investment. Over a period, there will be an averaging of the cost of fund units.
Lump-sum investments, on the other hand, need you to enter the market at an accurate time, when the situation is favorable, although there is higher level of risk. When you make investments in a lump sum during bull market conditions, the prices are higher for fund units.
Due to this reason, it is not usually recommended that you invest a lump sum in ELSS funds. A lot of investors rush to make ELSS funds investments at the last minute, for tax savings purposes. This leads them to choose lump-sum investments with no consideration for market trends.
It is of course a wiser approach to make plans beforehand, at the beginning of the financial year, and choose SIP investments. It will let you invest at an average rate and make tax savings.
Making ELSS funds Investments via SIP
When it comes to ELSS funds, the lock-in period is applicable for each purchase. This is applicable even if you opt for a monthly SIP.
To put it simply, the 3-year lock-in period applies for every monthly investment, beginning from the month of investment.
Also read: 5 Best Index Funds for 2024.
Growth & Dividend Choices
While considering investments in ELSS funds, you can choose between dividend and growth options. You can get periodic payouts under the dividend options all through your ELSS funds investment period.
In the growth option, on the other hand, dividends can be reinvested to obtain more units and ensure higher capital growth. The NAV (Net Asset Value) of units can get higher due to reinvested dividends. It can improve profits for investors, especially in favourable market situations.
Taxation Considerations
With ELSS funds, your units have a lock-in period of 3 years. This makes the resulting capital gains eligible for LTCG (Long Term Capital Gains) taxation. There is as much as ₹1, 00,000 tax exemption for LTCG from equity funds. Any amount that goes over this limit is subject to a tax of 10%.
In other words, you can stand to get two advantages. There is the opportunity to obtain as much as ₹1.5 lakh tax exemption every year for the entire period of your investment. When you redeem, your gains can stay tax-free for as much as ₹1 lakh.
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Conclusion
As you can understand, with ELSS (Equity Linked Savings Schemes) funds, you can get the advantages of wealth-building as well as tax-savings. By avoiding the accumulation of too many ELSS funds in your investment portfolio and making essential considerations such as having a short lock-in period and asset composition, you can make successful Investments.
