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ELSS - Equity Linked Savings Scheme

Team AckoJan 18, 2024

Investing in the right financial instruments is crucial for building wealth and securing a stable financial future. One such investment avenue that offers potential growth and tax benefits is Equity Linked Savings Scheme (ELSS).

In this comprehensive guide, we will delve into the world of ELSS and explore its benefits, risks, and strategies for maximising your investments. Whether you are a seasoned investor or a beginner taking your first steps into the world of finance, this article will provide you with valuable insights to make informed decisions.

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Contents

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What is ELSS?

ELSS is an abbreviation of Equity Linked Savings Scheme. It is a type of mutual fund that combines the benefits of tax-saving and potential capital appreciation through investments in equities. ELSS funds are managed by professional fund managers who invest the corpus in a diversified portfolio of stocks across various sectors and market capitalizations.

How does ELSS work?

When you invest in ELSS, your money is pooled with that of other investors and invested in a portfolio of equity stocks. The performance of the ELSS fund is directly linked to the performance of the underlying stocks. The returns generated by the fund are then passed on to the investors in proportion to their investment.

Why choose ELSS over other investment options?

ELSS offers several advantages over other tax-saving instruments. Firstly, it comes with a shorter lock-in period of three years compared to other options like Public Provident Fund (PPF) or National Savings Certificate (NSC), which have lock-in periods of 15 years and 5 years, respectively. Additionally, ELSS has the potential to provide higher returns due to its exposure to equities. Furthermore, the tax benefits offered by ELSS make it an attractive investment option for individuals looking to save on taxes while earning potentially higher returns.

Benefits of Investing in ELSS

1. Tax Benefits of ELSS

One of the primary reasons investors flock to ELSS is the tax benefits it offers. Investments in ELSS are eligible for tax deductions, up to a maximum of Rs. 1.5 lakhs. This means that the amount invested in ELSS can be deducted from your taxable income, thereby reducing your tax liability. Additionally, the long-term capital gains (LTCG) earned from ELSS investments are tax-free up to Rs. 1 lakh in a financial year.

2. Potential for Higher Returns

ELSS has the potential to deliver higher returns compared to other traditional tax-saving instruments such as fixed deposits or government bonds. Since ELSS invests in equities, it offers exposure to the growth potential of the stock market. Over the long term, equities have historically outperformed other asset classes, thereby providing the opportunity for higher returns on investments.

3. Diversification of Portfolio

Investing in ELSS allows you to diversify your investment portfolio. ELSS funds invest in a diversified range of stocks across sectors, which helps in spreading the investment risk. By investing in multiple stocks, the impact of a decline in the value of any single stock is reduced, thereby safeguarding your investment from significant losses.

4. Lock-in Period and Liquidity

ELSS comes with a mandatory lock-in period of three years from the date of investment. During this period, you cannot redeem or withdraw the invested amount. However, the lock-in period of ELSS is the shortest among all tax-saving investments. Once the lock-in period is over, you have the flexibility to either redeem the entire investment or stay invested for further growth. This provides investors with liquidity options and the ability to realign their investment strategy if required.

Strategies for Maximising ELSS Investments

1. Systematic Investment Plan (SIP)

One of the most popular strategies for investing in ELSS is through a Systematic Investment Plan (SIP). A SIP allows you to invest a fixed amount at regular intervals (monthly, quarterly, etc.). By investing regularly, you benefit from rupee cost averaging, where you buy more units when prices are low and fewer units when prices are high. This helps in reducing the impact of short-term market fluctuations and ensures disciplined investing.

2. Timing the Market

Timing the market refers to the practice of trying to buy or sell investments based on predicting market movements. While it may seem tempting to try and time the market to maximise your ELSS returns, it is often a challenging task even for seasoned investors. Instead of trying to time the market, it is advisable to stay invested for the long term and focus on the fundamentals of the ELSS fund.

3. Portfolio Diversification

Diversification is a key strategy for managing investment risk. By investing in multiple ELSS funds across different asset classes and market sectors, you can spread your investment risk and potentially enhance returns. Diversification helps in reducing the impact of any single stock or sector-specific risk on your overall investment portfolio.

4. Monitoring and Reviewing Investments

Regular monitoring and reviewing of your ELSS investments are essential to ensure that your portfolio is aligned with your financial goals and risk appetite. Keep track of the performance of the ELSS funds you have invested in and review them periodically. If any fund consistently underperforms or if your investment goals change, consider reallocating your investments accordingly.

ELSS vs. Other Tax-saving Instruments

1. ELSS vs. Public Provident Fund (PPF)

ELSS and Public Provident Fund (PPF) are both popular tax-saving options, but they differ in terms of lock-in period, returns, and liquidity. ELSS has a less lock-in period  (3 years) while PPF has a longer lock-in period (15 years). ELSS has the potential to generate higher returns due to its exposure to equities, whereas PPF offers fixed returns. Additionally, ELSS provides liquidity after the lock-in period, while PPF allows partial withdrawals only after a certain period.

2. ELSS vs. National Savings Certificate (NSC)

ELSS and National Savings Certificate (NSC) are two different investment avenues for tax-saving purposes. ELSS offers the opportunity to invest in equities and potentially earn higher returns, while NSC is a fixed-income instrument with a fixed interest rate.  ELSS has a less lock-in period (3 years), while NSC has a lock-in period of five years. Both options have their own advantages and it's important to consider your risk appetite and investment goals before making a choice.

3. ELSS vs. Unit Linked Insurance Plans (ULIPs)

Unit Linked Insurance Plans (ULIPs) and ELSS are both investment-cum-insurance products. However, they differ in their structure and investment approach. ULIPs offer life insurance coverage along with the option to invest in various asset classes such as equities, debt, or a combination of both. ELSS, on the other hand, focuses solely on equity investments. While ULIPs provide insurance coverage, ELSS primarily aims at wealth creation through equity investments. It's important to evaluate your insurance needs and investment goals before deciding between ULIPs and ELSS.

Risks Associated with ELSS

1. Market Volatility

As ELSS invests in equities, it is exposed to market volatility. The value of your investment can fluctuate based on the performance of the underlying stocks and the overall market conditions. It's important to understand that equities can be subject to short-term fluctuations, and investing in ELSS requires a long-term perspective to ride out market volatility.

2. Economic and Political Factors

Economic and political factors can have a significant impact on the performance of equities and, consequently, ELSS funds. Changes in government policies, global economic trends, interest rates, and inflation can influence the performance of the stock market. It's essential to stay informed about these factors and their potential implications for your ELSS investments.

3. Sector-specific Risks

ELSS funds invest in a diversified portfolio of stocks across sectors. However, certain sectors may be more susceptible to risks than others. For example, sectors like technology or pharmaceuticals may have their own unique risks and opportunities. It's important to understand the sectoral composition of the ELSS fund you are investing in and evaluate the associated risks.

4. Liquidity Risks

During the lock-in period of three years, you cannot redeem or withdraw your ELSS investment. This can pose liquidity risks if you require immediate access to your funds. Therefore, it's crucial to consider your liquidity needs and ensure that you have sufficient emergency funds or alternative sources of liquidity in case of unforeseen circumstances.

Wrapping up

ELSS presents an attractive investment option for individuals seeking tax benefits and potential capital appreciation. By investing in ELSS, you can not only save taxes but also participate in the growth of the stock market. However, it's important to understand the risks associated with equity investments and have a long-term investment horizon. Remember to assess your financial goals, risk appetite, and consult with a financial advisor before making any investment decisions.

Frequently Asked Questions (FAQs)

Here are some common questions about ELSS

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What is the minimum investment required in ELSS?

The minimum investment amount for ELSS varies across mutual fund companies. It can range from as low as Rs. 500 to Rs. 5,000. It's important to check the specific requirements of the mutual fund scheme you are interested in.

Can NRIs invest in ELSS?

Yes, Non-Resident Indians (NRIs) can invest in ELSS funds. However, certain mutual fund companies may have specific guidelines or restrictions for NRIs. It's advisable to consult with a financial advisor or the mutual fund company for the detailed process and requirements for NRI investments in ELSS.

Is ELSS suitable for short-term investments?

ELSS is primarily designed as a long-term investment avenue. The lock-in period of three years ensures that investors stay invested for the long term to benefit from potential equity returns. While short-term investments in ELSS are possible, it's important to consider the volatility of the stock market and the potential impact on short-term returns.

How can one claim tax benefits on ELSS investments?

To claim tax benefits on ELSS investments, you need to mention the investment details in the relevant section (Section 80C) of your income tax return. Ensure that you retain the investment proof, such as the statement or certificate provided by the mutual fund company, for future reference or if required by the tax authorities.

Can ELSS be held jointly with a spouse?

Yes, ELSS investments can be held jointly with a spouse. Joint holding of investments provides flexibility and allows both spouses to contribute towards the investment and avail tax benefits. It's important to check the guidelines of the mutual fund company regarding joint holding and the process for the same.

Are ELSS returns guaranteed?

No, ELSS returns are not guaranteed as they are subject to market risks. The performance of ELSS funds depends on the performance of the underlying stocks and the overall market conditions. While ELSS has the potential to deliver higher returns, it's important to note that equity investments come with inherent market risks and investors should be prepared for fluctuations in the value of their investments.

Disclaimer: The content on this page is generic and shared only for informational and explanatory purposes. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making any related decisions.

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