The last three months of the financial year are often spent looking for ways to save tax. Some investment options, like the Public Provident Fund (PPF), National Saving Certificate (NSC), etc., help you save tax under Section 80C of the Income Tax Act. But what if you find an investment option that not only keeps your tax but also creates wealth?
Equity Linked Saving Scheme (ELSS) is an excellent investment avenue with an edge over other options. It lets you save your tax and helps in capital appreciation.
Let’s discuss ELSS and how to invest in ELSS funds.
Know About ELSS Funds
Equity Linked Savings Schemes or “ELSS” funds are a category of equity mutual funds that come with a lock-in period of three years. It means you can’t withdraw money before the completion of the stipulated tenure. On completion of the lock-in period, you can either redeem your scheme or continue with it.
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Why Should You Invest in ELSS Funds?
ELSS funds have proven beneficial in saving tax and yielding returns in the long run. Following are some of the benefits of ELSS funds:
- Any investment towards ELSS funds enjoys tax benefits up to Rs 1.5 lakh under Section 80(C) of the Income Tax Act. Further, as there is no long-term capital gain tax on investments, the returns on maturity are tax-free.
- As your investment, dividends, and maturity amount are tax-free, ELSS enjoys Exempt, Exempt, Exempt (EEE) tax status.
- The lock-in period of ELSS funds is much lower than that of PPF, National Savings Certificate, and bank deposits.
- The highest-ranked ELSS funds have given a compound annual growth rate (CAGR) of more than 15% in the past five years— far more than the other options like PPF and NSC, which can give returns in the range of 6%-9% only.
- Though money can be withdrawn after three years, investors can stay invested as long as they want
- An investor can opt for a tax-free dividend option within the lock-in period for periodic cash flow.
Here is a comparative analysis of ELSS with other investment options of Section 80C
| Parameters | ELSS | 5-year Bank Fixed Deposits | Unit-Linked Insurance Plans (ULIPs) | NSC | |
| Taxability on the maturity amount | Tax-free | Tax-free | Taxable if the total interest on bank fixed deposits is more than Rs 10,000 in one year. | Tax-free | Interest earned is taxable. |
| How to Invest in ELSS: Systematic Investment | Available | Available | Not Available | Available | Not Available |
| Lock-in period | Three years | 15 years (partial withdrawals are allowed from the 7th year onwards) | Five years | Five years | Five years |
| Investment risk | High | No risk | No risk | High | No risk |
| Returns | Equity-lined returns | 7.80% | 6%-9% | Market-linked returns | 7.80% |
While ELSS is the best way to save tax and create wealth, here are a few things that should be considered to maximize your returns:
Understand the Risks
Unlike traditional investment options like PPF and NSC, ELSS is not risk-free. As the returns are linked to stock market movements, your fund value may fluctuate as per the market conditions. Investing with a thorough understanding of the risks will give you more opportunities to optimize your returns. Moreover, the lock-in period of three years helps investors to tide over the market volatility.
Stay Invested Beyond Lock-in Period
Though the stipulated lock-in period in ELSS funds is three years, it is strongly advised to stay invested for a minimum of five years to meet long-term goals. The longer you stay invested in ELSS, the more you can gain from the power of compounding and rupee cost averaging.
Go with the Growth Option Instead of Dividend Option
Though the dividend option gives periodical liquidity from your ELSS fund, it can cause damage to your long-term goals by not allowing the power of compounding to show its magic. As the gains are paid out and not reinvested, you can lose compounding effects. However, by investing in the growth option, you can ensure that profits are reinvested and grow at the same rate as your principal amount.
How to Invest in ELSS?
Instead of investing lump-sum in ELSS by the end of the financial year to save tax, it makes more sense to invest through systematic investment plans (SIPs) systematically. You can start investing in ELSS through SIPs as small as Rs 500.
Not only will it fall easily into your pocket, but it will also curtail market risks through rupee cost averaging. Making a lump-sum payment means you may miss out on the best price, but a SIP approach ensures that you make systematic payments and come close to getting the best price.
ELSS comes loaded with triple benefits— high returns, controlled risks, and three layers of tax advantages, so this tax season, grow your wealth and save tax simultaneously.
