Understanding a few lesser-known facts about ELSS

ELSS or Equity Linked Savings Scheme is a popular tax saving mutual fund that allows investors to claim tax deduction of up to Rs. 1.5 lakh under section 80C of the Income Tax Act, 1961. By directing funds into ELSS, one can enjoy both tax benefits as well as equity returns in the long run.
However, there are a few nuances of ELSS that are often overlooked. Let's understand some lesser known ELSS fund facts.

• Table of contents

1. Lower lock-in period compared to other tax saving options
2. Strategies to manage the 3-year lock-in
3. Built-in diversification through equity exposure
4. Taxation aspects and benefits of ELSS
5. Comparison with other fixed income options
6. Selecting the right ELSS fund
7. FAQ

Lower lock-in period compared to other tax saving options

To start with, ELSS follows the principle of asset allocation by investing primarily in quality stocks. This equity orientation makes it suitable for potential capital appreciation over the longer term. Thus, considering the longer run performance of Indian equities along with tax deductions, ELSS can be a highly effective wealth creation tool when used for 5-7 years or more.

However, what differentiates ELSS from regular equity mutual funds is its three-year lock-in period. While this lock-in is mandatory to avail of tax breaks under section 80C, it is the shortest across different tax saving tools.

For example, Public Provident Fund (PPF) and National Pension Scheme (NPS) have lock-ins of 15-20 years. Even employees' provident fund (EPF) amounts cannot be withdrawn instantly. In comparison, the three-year lock-in of ELSS provides adequate flexibility to the investor

Strategies to manage the 3-year lock-in

After the mandatory three years, investors can redeem or continue with the ELSS fund based on their financial goals and market conditions prevailing at that time. This feature provides ELSS an edge over other long-term options available for tax planning under section 80C.

For example, someone planning for a child's higher education after 10-12 years can start with 60% equity allocation through ELSS in the beginning and gradually reduce it by redeeming ELSS units post lock-in period and diverting the amount to ultra-short term or corporate bond funds over the years.

Built-in diversification through equity exposure

Just like any equity mutual fund, ELSS also provides built-in diversification as the pooled money gets invested in 30-50 stocks spanning different sectors of the economy. In other words, by investing a lumpsum amount – or better still through SIPs for 1-2 years – one's risk gets diversified without having to construct a diversified portfolio on one’s own. This significantly reduces company or sector-specific risks over the long term.

Taxation aspects and benefits of ELSS

Now coming to another important aspect - taxation. Any mutual fund investment held for less than one year is treated as short term capital gains (STCG) and taxed at the investor's income tax slab rate. However, switching to ELSS provides benefits of long term capital gains by default due to the lock-in period. For units redeemed or sold after three years, the long term capital gains above Rs. 1 lakh are taxed at just 10%.

Comparison with other fixed income options

When compared to popular fixed income options – like PPF, 5-year Bank FDs or Post Office schemes – the after tax returns from a diversified ELSS fund over a 10-15 year period usually tend to outperform given the equity orientation and benefits of compounding.

Selecting the right ELSS fund

To minimize risks, reputed fund management and a good track record assume great importance while shortlisting ELSS options. Features like low expense ratio, optimal portfolio turnover, prudent stock/sector selection as well as performance consistency are some parameters one can evaluate funds on. A disciplined SIP approach is also advisable for remaining invested during market fluctuations.

conclusion

ELSS allows benefitting from equity returns within tax saving limits if used with a long-term perspective of 5-10 years or more. By choosing the right ELSS combination aligned with one's risk profile and financial goals, it can emerge as one of the suitable tax planning tools available under Indian tax laws. Ensure you understand the above-mentioned facts about ELSS fund and avail yourself of the services of a financial advisor for better results.

FAQs:

Can I invest a lumpsum amount in ELSS to claim tax deductions?
A. Yes, you can invest a lumpsum amount in ELSS up to Rs. 1.5 lakh in a financial year and claim tax benefits under Section 80C. However, investing through SIPs helps in rupee-cost averaging and reduces market timing risks.

Is it advisable to redeem ELSS after 3 years?
A. It is not mandatory to redeem after the 3-year lock-in period. One may continue with the ELSS investment for wealth creation over long term. Redeeming after three years makes sense only if you need the money for a specific financial goal. Else, allowing long term compounding through equity exposure can generate potentially good returns.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.