ELSS vs SIP: How to make investment decision for optimising returns

Mutual funds have been around for a long time and remain a popular way to grow wealth over the long term. And yet, with so many options available, mutual funds can often be confusing for new investors. Among the most discussed investment vehicles in India are Equity-Linked Savings Schemes (ELSS) and Systematic Investment Plans (SIP). While both ELSS schemes and SIP investment plans can be powerful tools for building a financial future, they serve different purposes and have distinct characteristics.

Understanding their key differences can help you make an informed choice for building a robust investment portfolio.

• Table of contents

• Properties of ELSS schemes and SIP investment plans
• What is an equity-linked savings scheme (ELSS)?
• What is an SIP investment plan?
• ELSS vs SIP: 5 key differences that you must know about
• ELSS vs SIP: Which is more suitable?
• ELSS vs SIP: Make the right selection and reap rich dividends

Properties of ELSS schemes and SIP investment plans

Both ELSS and SIP are linked to mutual fund investments, but they differ significantly in their structure and purpose. ELSS mutual fund is a type of tax-saving investment, while SIP is a method of investing that allows for disciplined, regular contributions into mutual funds.

So, a direct “ELSS vs SIP” comparison is like a comparison between apples and oranges. However, understanding Equity-linked Savings Schemes and SIP investment plans in detail can help you find suitable investment option for your needs.

What is an equity-linked savings scheme (ELSS)?

An Equity-Linked Savings Scheme (ELSS) is a mutual fund scheme that primarily invests in equities or shares of companies. ELSS is designed to provide tax benefits under Section 80C of the Income Tax Act, 1961, allowing investors to claim deductions of up to Rs. 1.5 lakh per year. These schemes are managed by Asset Management Companies (AMCs) and typically invest in a diversified portfolio of stocks.

Here are 3 features of ELSS:

• ELSS schemes are characterised by a compulsory three-year lock-in period.
• ELSS mutual funds offer a potential for reasonable returns due to their equity exposure.
• Equity-Linked Savings Scheme come with a higher degree of risk as they are susceptible to market fluctuations.

What is an SIP investment plan?

An SIP is a flexible investment method that allows investors to contribute a fixed amount regularly (daily, weekly, monthly, quarterly, etc.) into a mutual fund scheme. The primary advantage of SIP is that it encourages disciplined, long-term investing and helps mitigate the effects of market volatility through rupee cost averaging.

Here are 3 features of SIP:

• SIP investment plans can be used to invest in various types of mutual funds, including equity, debt, hybrid, and ELSS funds.
• An SIP is apt for long-term investments as it helps investors tap into the potential offered by the rupee cost averaging principle.
• SIPs are not restricted by tax laws and do not have a lock-in period on their own.

ELSS vs SIP: 5 key differences that you must know about

• Nature of investment: ELSS is a type of mutual fund that primarily invests in equities, with the aim of providing tax-saving benefits under Section 80C of the Income Tax Act, 1961. While a SIP investment plan is a method of investing in mutual funds including equity, debt, hybrid, or even ELSS.
• Tax benefits: Investors can avail annual deductions of up to Rs. 1.5 lakh from their taxable income for their ELSS scheme investments under Section 80C of the Income Tax Act, 1961. SIPs do not offer direct tax benefits.
• Lock-in period: An ELSS mutual fund has a mandatory lock-in period of three years, meaning you cannot withdraw your funds before the three-year period is over. SIPs do not have their own lock-in period since it depends on the mutual fund scheme you choose.
• Risk and return: Since Equity-linked Savings Schemes predominantly invest in equities, they come at a relatively higher risk level. Additionally, they offer the potential for higher returns over the long term. SIPs can be used for different types of funds, each with varying risk and return profiles.
• Flexibility: ELSS schemes offer tax savings but are less flexible due to the mandatory lock-in period. SIPs are highly flexible since you can adjust the contribution amount, SIP instalment frequency, or even switch funds as your financial goals evolve.

ELSS vs SIP: Which is more suitable?

The decision between ELSS vs SIP largely depends on your financial objectives, risk tolerance, and investment horizon.

● If your primary goal is to save taxes, the ELSS mutual fund is a strong choice. It offers a reasonable return potential due to its equity exposure, and the tax benefits make it appealing for those seeking to reduce their tax burden.

● If you prefer a disciplined, long-term investment strategy and want to invest in a range of mutual funds, an SIP investment plan can be considered. SIPs offer more flexibility and allow you to start with smaller amounts, making them suitable for both beginners and seasoned investors.

ELSS vs SIP: Make the right selection and reap rich dividends

Choosing between ELSS and SIP is not always an either-or decision since both are completely different things. One is an investment instrument and the other is a method of investing. You can determine which strategy suits your needs by evaluating your personal financial goals, risk appetite, and investment horizon.

If you are looking for tax savings with the potential for capital appreciation, ELSS via SIP could offer the best of both worlds. Therefore, it is not really a question of ELSS vs SIP.

SIP can also help you invest a fixed amount regularly into your ELSS mutual fund promoting disciplined, long-term investing.

In conclusion, understanding the key differences between ELSS Mutual Funds and SIP investment plans can help you navigate the complex world of mutual fund investing in India. While ELSS provides a tax-saving opportunity with higher equity exposure and a lock-in period, the SIP method of investing offers greater flexibility and convenience. By selecting a suitable investment approach and staying committed to your long-term financial goals, you can optimise the return potential and build a stable financial future.

FAQs:

What are the tax implications for the redemption of ELSS fund investments?

Redemption of Equity-linked Savings Schemes is subject to long-term capital gains tax (12.5%) if gains exceed Rs. 1.25 lakh in a financial year.

Is SIP good for ELSS?

Yes, SIP can be a way of investing in ELSS schemes, as it promotes disciplined investing, reduces market timing risks, and offers compounding benefits.

How do I know if my SIP is ELSS?

Check the fund's name or consult your fund provider to identify if your SIP is an ELSS mutual fund.

Is ELSS SIP tax-free?

No, ELSS SIP investment plans are not tax-free in India. While it offers tax benefits under Section 80C of the Income Tax Act, 1961, long-term capital gains above Rs. 1.25 lakh in a financial year are taxed at 12.5%. Also, ELSS mutual funds provide tax deductions of up to Rs 1.50 lakh annually under Section 80C of the Income Tax Act, 1961.

Is NPS better than ELSS?

National Pension System (NPS) offers tax benefits and a steady retirement income to investors whereas Equity-Linked Savings Schemes provide relatively better return potential in the long term but with higher risk. NPS may be more suitable for long-term retirement goals, while ELSS suits tax-saving needs.

What are the disadvantages of ELSS?

ELSS schemes have a three-year lock-in which affects their liquidity. They also carry market risk due to equity exposure, which may lead to short-term volatility and potential losses during market downturns.

Is ELSS maturity tax-free?

Gains from ELSS funds are categorized as LTCG and taxed at 12.5% for gains above the exempted amount of Rs. 1.25 in a financial year.

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.