Equity Linked Savings Schemes

The term “equity-linked savings schemes” (or “ELSS”) relates to mutual funds instituted to invest mainly in stock and equity related instruments, and they are also tax saving mutual funds. ELSSs are both capital gains and tax deductible for taxpayers under Section 80C of the Income Tax Act of 1961, up to ₹1.5 lakh in a financial year. ELSS schemes also keep a low lock-in period of three years for tax saving investments.

Equity Linked Savings Funds (ELSF) are under the umbrella of ELSS. They support diversified equity investments for generating wealth over the longer term. Though market risk is incurred, they normally provide a better potential return than conventional methods of tax saving such as the Public Provident Fund (PPFs) or Fixed Deposits.

If you are someone who wants to build wealth while using tax savings as the vehicle, then ELSS is for you. This asset class carries returns specific to market performance, hence it is suitable for high to medium risk profile people with long term investment time horizons.

Features of ELSS

1. ELSS investment qualifies for tax exemptions up to ₹1.5 lakh under Section 80C of the Income Tax Act, thereby reducing taxable income.
2. Among different tax saving schemes of investment, ELSS boasts the least lock-in period of three years.
3. The funds invest at least 80% in equities and equity linked instruments, which involves some risk but the potential for astronomical returns.
4. The investors can opt between a dividend payment option or growth option, or go for a dividend reinvestment plan, as per their investment requirements.
5. With its equity orientation, ELSS must be capable of providing returns greater than the traditional tax saving instruments such as Public Provident Fund (PPF) and fixed deposits.
6. No early release is permitted because the three-year lock-in allows for the development of the habit of disciplined investing.
7. It is flexible in investment mode through Systematic Investment Plan (SIP) or lumpsum investment.
8. The returns on ELSS are taxed at 10% Long-Term Capital Gains (LTCG) if overall capital gains in a financial year are more than ₹1 lakh.

Factors to Consider before Investing in ELSS

There are many aspects of ELSS as an investment, whether it is attracted as a tax saving option to reduce the burden of investment under Section 80C or as a way to enjoy the growth prospect of the equity market. However, being an investment linked to the market, ELSS is not without risk and other conditions attached. Therefore, investors must think about many things before making an investment in an ELSS product to ensure that it is appropriate for their financial objectives, risk profile, and investment strategy.

Investing in ELSS might be beneficial, as it provides tax benefits and accumulation of wealth over a longer term. However, many market circumstances and risk elements are there, whose clarity should be sought by the investor. ELSS ideally suits long-term investors with a high to medium risk appetite and the need for wealth accumulation. Wise planning and timely revisits can keep the investor in touch with high benefits and the right stomach of risk.

1. Investment goals and financial needs

Before investing in ELSS, the investors should first figure out their sole purpose, whether to save taxes or accumulate wealth in the future or both. ELSS is good for a long term growth oriented investor who also seeks to save taxes.

2. Lock-in period and liquidity restrictions

ELSS funds have a three year lock-in period, which disallows early withdrawal.  ELSS funds are not like other mutual funds in that they do not permit flexible redemptions.

3. Risk Appetite and Market Volatility

ELSS invests largely in equity; therefore, mainly comes under market volatility. It is important for investors to keep risk appetite in mind when investing in ELSS, as returns can vary with market dynamics.

4. Past Fund Performance and Fund Manager Expertise

Analysing an ELSS fund’s 5-10 year track record can provide insight into its consistency and reliability, albeit previous performance cannot guarantee future returns. Compare ELSS funds based on their annualised returns over 3, 5, and 10 years. Performance throughout market downturns and recoveries. The fund manager has experience managing market volatility. Prioritise long term risk adjusted returns over short term gains when selecting funds.

5. Fund Portfolio and Diversification

ELSS funds make investments in large cap, mid cap, and small cap equities. The right fund must have a properly diversified portfolio across market capitalization and sectors. There may be ELSS funds where there is too much concentration in specific sectors, which can lead to higher risk exposure.

6. Redemption Strategy after the Lock-in Period

After completion of the lock-in period of three years, investors can opt to redeem investments, change investment to another fund, or continue with the current investment. ELSS schemes are meant to build wealth in the long run; hence, instead of withdrawing money once the lock-in period is over, investors would do well to stay invested for better returns. It would be best to evaluate market conditions before such investments are redeemed to maximise returns.

7. Investment Strategies

ELSS investment options are basically of two types:

• SIP (Systematic Investment Plan): Involves investing a fixed sum every month in order to minimise the effect of market volatility and impart discipline to investing.
• Lump Sum: Means suddenly investing a large sum, helping when prices are low in the market, but causing risk in unstable market times.

8. Tax Impact on Returns

ELSS is a Section 80C investment that provides tax benefit, but the profits are taxed under Long Term Capital Gains Tax:

• Gains up to ₹1 lakh per annum stand tax-free.
• Gains in excess of ₹1 lakh will be taxed @10% without any benefit of indexation.
• While PPF and EPF give fully tax-free returns, ELSS is partially taxed on returns.

9. Expense Ratio of the Fund

Expense ratio means the fees charged for managing a fund by a mutual fund house. Low expense ratio will allow a higher percentage of your investment to stay invested for growth in the future. An average cost ratio for an ELSS fund lies in the range of 0.5%-2%, depending on whether it is actively managed or passively managed.

Importance of ELSS

Equity linked savings schemes (ELSS) play an important role in an investor’s portfolio, providing tax benefits along with opportunities for wealth creation. Its shorter lock-in period combined with the potential for long-term growth and tax efficient returns makes it an attractive vehicle for investors seeking tax relief and monetary appreciation. However, because ELSS is market dependent and entails risks, investors must assess their risk appetite, investment horizon, and financial goal before investing.

1. Tax Benefits under Section 80C

Tax benefits under Section 80C are big props for ELSS, where tax deduction up to ₹1.5 lakh can be availed. This facility thus allows the investor to reduce his taxable income and in turn his tax liability. In comparison, the other tax saving schemes like PPF, EPF, and NSC, ELSS has potential when compared with other schemes to give better returns, as it is linked with equity markets.

2. Among all tax saving investment schemes, it has the least lock-in time

The lock-in periods of Equity Linked Savings Schemes (ELSS) are mandatory by law for a maximum of three years only, which makes it shorter compared to other investment vehicles for tax savings, for example –

• Public Provident Fund – 15 years;
• National Savings Certificate – 5 years;
• Tax-saving fixed deposits (FDs) – 5 years.

A shorter lock-in period increases liquidity so that the investor is more free to re-invest his funds or assign it to a different investment compared to other tax saving instruments.

3. The potential for enormous gains

The maximum investment, particularly in equity, is done by ELSS funds while an investment in infrastructure is totally dependent upon traditional tax saving. Unlike in fixed income securities that promise a consistent return in a low growth rate (6-8%), ELSS has provided returns of approximately 10-15% in the longer term. These returns, however, are dependent on the market, and they ebb and flow, adding a further element of risk, higher return investments.

4. Encourages long term wealth creation

Equities are held for the most part for the purposes of a longer time frame, such that they usually realise the best results. ELSS, thus, makes sure that investors invest for at least three years. Compounded benefits would be on account of increase in potential financial discipline on the part of investors during the lock-in period, which would be long enough to accrue long-term capital growth. History has shown that, within a longer investment horizon, returns on equity investments have outpaced inflation, thus resulting in wealth accumulation over the long term.

5. Flexibility in Investment Mode (SIP or Lump Sum)

ELSS has two investment modes for investors. One mode is the systematic investment plan, which facilitates small investments at regular intervals (e.g., weekly) to reduce the impact of volatility in the market. At the same time, it also promotes an investment discipline. The second mode is lump sum investments, which are ideal for making large investments, especially during market corrections. It guarantees that ELSS is affordable for various types of investors, regardless of their economic status.

6. Professional Management and Diversification

ELSS funds are defined as having a high degree of inter-industry and size diversification to reduce the overall risk. Fund managers are actively monitoring these portfolios for the identification and collection of high-quality equities, maximising the risk-adjusted returns. In addition to serving as balancing risks, this diversity strategy augments growth potential.

7. Expense Ratio Competitive with Other Mutual Funds

Typically, ELSS has a good expense ratio, ensuring that management fees do not dent returns much. A fund with a lower expense ratio could significantly assist long-term net returns.

8. Higher Returns Tax Efficiency

Investment in ELSS is not only tax saving but also has tax efficient returns over other tax saving methods. It is only charged a ten percent Long Term Capital Gains Tax on income exceeding ₹1 lakh in a year, as compared to short term capital gains taxes on stocks. ELSS also pays out dividends, which are tax effective and can be reinvested or taken post tax; therefore, making it a strong option for growth investors.

9. Suitable for the fresh investors and the novices

ELSS provides a wonderful opportunity to young working professionals and budding investors in terms of delving into the stock market with tax benefits, for example, budding investors can start as low as ₹500 per month through a Systematic Investment Plan (SIP).

10. Such as retirement and wealth creation financial goals

Investing in ELSS can serve as a great boost to achieving long term financial goals such as retirement, buying a house, funding children’s education, asset formation, etc. Since equity markets are known to provide better long term returns, ELSS efficiently works as a growth factor in an investor’s financial kitty.

Conclusion

When you want to invest under Section 80C and get tax benefits and growth over time, Equity linked savings schemes (ELSS) are the best options in the market. The lock-in period of three years in ELSS ensures saving while allowing liquidity as investment continues in the stock market. One of the best tax-saving schemes today is ELSS for investors willing to undergo market fluctuations for wealth creation, along with tax benefit consideration. Returns on ELSS are, however, dependent on market conditions, and so it becomes important for potential investors to ascertain their risk appetite and needs before investing. The best fund as per the research, a long investment horizon, and SIPs for regular investment can work wonders in maximising investment returns. ELSS is, therefore, a very good tool for wealth growth by the investor along with optimising his tax liability.