Things One Should Know Before Investing in ELSS

An equity-linked savings scheme (ELSS) is an investment that derives its earnings from the equity markets. ELSS funds come with a mandatory lock-in period of three years and the investor cannot withdraw their investment during this period. ELSS funds are popular as they are tax-saving instruments under Section 80C of the Income Tax Act and allow one to claim a tax deduction of up to Rs1,50,000.

Nevertheless, before investing in ELSS funds, an investor should know some things, namely:

Risks

Investors who are looking for higher returns should be well-prepared for the risks and the volatilities of the equity market. ELSS funds are a type of mutual funds that invest only in the equity markets or equity-related products, which are known for their high volatility. Due to this volatility, which increases the risk-reward ratio, ELSS funds give higher returns than most investments.

Past Performance

Past performance is not a deciding factor when choosing for the best ELSS fund as the current top-performing fund might not perform so well in the future. Hence, the investor should conduct due diligence and have realistic expectations before investing in an ELSS fund. Balancing risk and reward by choosing the correct mix of schemes can help investors enrich their financial journey.

Investment Period

ELSS funds come with a mandatory lock-in period of three years, but there is no need of divesting the units immediately after the end of this term. In the equity markets, investors can take advantage of the power of compounding by staying invested for longer periods. This will allow your money to grow exponentially over the years. Investors can even reinvest their earnings into a different scheme if they do not wish to continue with their investment.

Reuse and Recycle

If the investor has been in the market for a long time, they can sell their investments and invest the proceeds in the market to maximize their earnings. ELSS funds also offer the option of dividend reinvestment, where the investor’s dividend returns are reinvested in the ELSS scheme and treated as a fresh investment. At the same time, if an individual has opted for the Systematic Investment Plan (SIP) route to invest in an ELSS, every SIP payment will be treated as a fresh investment with a separate lock-in period for each SIP.

For example, if the investor has made an SIP payment in July 2018, he/she can redeem it in July 2021, while the SIP payment of August 2018 can be redeemed in August 2021.

Taxation

Before the Union Budget of FY2018-19, long-term capital gains (LTCG) were tax-free in the hands of the investor. However, Union Budget FY18-19 introduced the LTCG tax of 10% on capital gains, including 10% dividends, exceeding Rs1 lakh. To tackle this issue of taxation, it is prudent for an investor to opt for a growth plan ELSS as it will help reduce your tax burden.

These are some of the things an investor should be aware of before investing in ELSS funds, which are an excellent option for saving tax. Do remember to conduct proper research before taking a decision.