The government has created a type of mutual fund known as Equity-Linked Saving Scheme or ELSS to encourage long-term investments. The average citizen is thus encouraged to invest a major part of their savings in equities through Equity Linked Saving Schemes by offering a tax deduction. There are many benefits of investing in an ELSS. To improve participation in equity, the government has allowed the investment in mutual funds to be tax deductible through ELSS schemes.
Five things you must know before investing in an ELSS:
- An investor can invest their money in Equity Linked Saving Schemes either as a lump sum or by systematic investment plan (SIP). The systematic investment plan approach allows you to invest in a planned and disciplined manner so its better for you.
There are a couple of advantages of SIP –
- Investing in SIP means your tax savings is divided in twelve months which reduces the effect of the investment on your liquidity. You miss out on buying at best possible price if you buy ELSS in a lump sum.
- SIP gives you the rupee cost averaging benefit.
- Under Section 80C of the Income Tax Act, ELSSs have the shortest mandatory lock-in period among all tax saving instruments which is three years. You cannot redeem any of your units during this period but you can get dividend payments. You must invest with an investment horizon of five to seven years to get best returns and stay longer in the market.
- You can invest up to 1.5 lakh in ELSS in a financial year and all ELSS investments are deducted from your gross income with respect to the Section 80C portion of Income Tax Act. However, ELSS receive the benefits of getting Exempt, Exempt, Exempt (EEE), meaning on investing in ELSS, you receive tax benefits and the dividends you receive are tax exempted as well.
- ELSS does not offer a guaranteed return on your investment, but it offers a market-linked return. Your wealth gets compounded by staying in the market for a longer period of time. You get to stay in the market for longer due to mandatory lock-in phase and are able to benefit from it.
- ELSS are equity-based mutual funds whose only motive is to invest in equity or equity-related assets. The broader motive of ELSS funds is to pay attention to the long-term generation of investor wealth.
Here’s an example of how an ELSS works:
Let’s say the NAV of your ELSS is Rs. 60 and you have 1,80,000 that you can invest. With that amount, 3000 units can be bought. You get a 30% exemption on this transaction as you are in the highest tax bracket which means you get a rebate of Rs. 54000. We are excluding cess and surcharge values for ease of calculation. You effective investment on the ELSS is now Rs. 126000.
Assuming an annual return of around 13% over three years (market average of last 3 years) the NAV of the fund is Rs. 86.5, thus giving you a return of Rs. 2,59,500 which is more than double the effective investment.