The number of investors purchasing ELSS funds are rising on a daily basis. Find out the reason for its success.
Over the years, ELSS mutual funds have scored very well in comparison to other financial instruments such as savings bank deposits, fixed deposits (FDs) and Public Provident Fund (PPF). What makes an ELSS mutual fund special? Is it necessary to have an ELSS mutual fund in your investment bucket? Read ahead to know more.
To begin with, let us understand what an ELSS mutual fund is.
What is an ELSS Mutual Fund?
An ELSS or Equity Linked Savings Scheme is a type of mutual fund which invests primarily in equity and equity related instruments. Equity comprises of shares and stocks of large corporations with extensive market capitalization. Since equities are traded on the stock market, their returns are generally high and depend on the performance of the market. What makes an ELSS mutual fund special is the fact that it is the only type of mutual fund which comes with the dual benefit of wealth creation and tax saving. Investment towards an ELSS mutual fund is eligible for tax deduction of upto ₹1.5 lakhs under Section 80C of the Income Tax Act, 1961.
Benefits of ELSS Mutual Funds
The benefits of investing in an ELSS mutual fund are:
Tax Saving - This is indeed the primary benefit of investing in equity linked savings scheme plan. An amount of upto ₹1.5 lakhs is available for tax deduction per financial year under Section 80C of the Income tax Act, 1961. An ELSS mutual fund is the only mutual fund where you can claim tax deductions.
Lock-in Period - ELSS mutual funds come with a mandatory lock-in period of 3 years in comparison to 5 years or more with respect to other tax saving instruments. PPF comes with a lock-in period of 15 years. Also, an ELSS mutual fund provides the highest returns with the lowest lock-in period.
Long Term Capital Gains Tax - Returns in an ELSS mutual fund post the three year mark are considered as long term gains. Gains above ₹1 lakh are taxed at the rate of 10% under LTCG tax.
Compounding - When you stay invested in an ELSS mutual fund for a period of 5-7 years, not only are you inculcating a disciplined habit of savings, your investment is also subject to the power of compounding.
Higher Returns - ELSS mutual fund invests primarily in equity funds. Equity funds have a higher rate of return (15%-20%) in comparison to other tax saving options (7%-10%).
Before you think about parking your money in an ELSS mutual fund, here are 5 common mistakes you should avoid.
Don’t exit immediately after 3 years
One of the most lucrative reasons why people invest in an ELSS mutual fund is to save tax. In order to save tax, you have to keep your investment locked-in for 3 years. Yes, an ELSS mutual fund comes with a mandatory lock-in period of 3 years. Other financial instruments such as FDs, PPF and long term deposits have a lock-in period of 5 years or more. Investors usually tend to book profits once the fund has completed its 3 year tax break and make an exit. If the mutual fund is performing well, there is no need for you to walk out; it’s best to stay invested. In fact, stay invested for as long as you want. Staying invested for a longer duration will only increase your returns. Another plus point is that an ELSS mutual fund is managed by professional fund managers, you do not have to look after your investment on a day-to-day basis.
Section 80C Limit
Investors often look at ELSS mutual fund as the last resort of saving tax right before the financial year. Investing in an ELSS mutual fund for the purpose of tax benefits is not sufficient. Sooner or later, your Section 80C limit will get exhausted and seem inadequate. This is applicable as your income increases. You should look at the long term benefits of an ELSS mutual fund investment. Over the long term, more and more money will get invested and will ultimately lead to high returns. Therefore, you should look beyond the limits of Section 80C.
Systematic Investment Plan
Investment in an ELSS mutual fund should be done via SIP. This has its many benefits. First, your SIP will correlate with your monthly outflows and inflows. Second, you will gain from the benefit of rupee cost averaging in times of market volatility. Third, the lock-in period of an ELSS starts from the date of investment. This means that the lock-in period will begin exactly from the month of investment for each SIP. This gives an investor a one year advantage in making their ELSS fund more liquid.
Multiple ELSS Funds
Many investors have the habit of selecting ELSS mutual funds issued by different banks/asset management companies. Over the investment years, they end up taking multiple ELSS mutual funds from 7-8 AMCs. This is not an ideal situation as every ELSS fund requires some time and effort. You need to track the performance, check the indexes, be aware of the competition, control the expense ratio and revise the portfolio if needed. The more ELSS mutual funds you have, the more time and effort will be required to check the performance. Therefore, it is ideal to track close to 1-2 ELSS mutual funds instead of holding 7-8 ELSS mutual funds.
The very purpose of an investment begins with two things - Your risk appetite and the financial plan. Your sense of perspective will determine how much investment is required in an ELSS mutual fund. This is heavily dependent on your risk appetite. Investing in an ELSS mutual fund should be a part of your overall financial plan/goal. This will further help you understand your purpose of investment. You will definitely end up saving tax with an ELSS mutual fund, but it can backfire if it does not fit in your overall financial plan. Recently, ELSS mutual funds have become a popular choice among investors for the purpose of tax saving. As mentioned before, over the years ELSS mutual funds have performed pretty well in the market. They have an excellent track record with respect to high returns. The popularity of ELSS mutual funds is the reason why it has surpassed PPFs, FDs and SBDs to become a preferred investment choice.
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