Indian equity-linked savings schemes (ELSS) have gained immense popularity in the field of tax-saving investments in recent years.
As a result of their unique combination of tax benefits, wealth creation potential, and ease of investing, ELSS funds have become a go-to choice for investors looking for a way to save taxes while aiming for long-term financial growth and value creation. You can always use an ELSS calculator online for calculating projected returns.
It is the goal of this comprehensive guide to provide you with an insight into the nuances of investing in ELSS and to help you make informed investment decisions by exploring their benefits, risks, and expected returns.
What are Equity-Linked Savings Schemes (ELSS)?
ELSS are mutual funds that invest primarily in stocks and equity-related assets.
They have a statutory lock-in term, usually three years, which distinguishes them from other tax-saving vehicles such as the Public Provident Fund (PPF) and National Savings Certificate (NSC) which have higher lock-in periods.
Benefits of Investing in ELSS:
- Potential for High Returns
ELSS primarily invests in equities, offering the potential for significant capital appreciation over the long term. So, systematic investments in ELSS schemes can help to accumulate wealth.
Historically, ELSS funds have outperformed many other tax-saving options like Public Provident Funds (PPF) and Fixed Deposits (FDs) in terms of returns.
- Tax Benefits
ELSS are eligible for tax deductions as per the Income Tax Act 1961 under Section 80C, which allows investors to claim deductions of up to Rs. 1.5 lakh every fiscal year.
When the three-year lock-in period is met, the returns on ELSS investments are taxed as normal equity mutual funds.
This dual tax benefit makes ELSS a compelling choice for taxpayers seeking to optimise their tax liability.
- Short Lock-In Period
ELSS has a relatively short lock-in period of just three years when compared to other tax-saving investments with longer lock-in periods.
After the lock-in period ends, investors have the flexibility to redeem or continue holding their investments based on their financial goals.
- Professional Management
ELSS funds are managed by competent fund managers who make investment choices based on market circumstances and investment objectives.
This professional management can help optimise returns and manage risks effectively.
- Systematic Investment Option
ELSS funds offer the convenience of Systematic Investment Plans (SIPs), allowing investors to invest regularly and benefit from rupee cost averaging.
Risks Associated with ELSS Investments
- Market Volatility
ELSS invests largely in equity, which are exposed to market changes. As a result, the value of your investment can rise or fall based on market conditions. Investors must be prepared for short-term volatility and stay invested for the long term to potentially benefit from market upsides.
- Lack of Guaranteed Returns
Unlike fixed-income instruments like PPF or FDs, ELSS does not offer guaranteed returns. The returns are dependent on the performance of the underlying equity market. While this presents an opportunity for high returns, it also involves the risk of capital erosion. You can rely on ELSS calculator online to evaluate risks and returns
- Liquidity Constraints
The obligatory lock-in time for ELSS is three years. This means you cannot redeem your investments before this period, even in times of financial emergencies.
Investors must consider their liquidity needs and ensure they have other accessible assets in case of unforeseen expenses.
- Fund-Specific Risks
Each ELSS fund has its own investment strategy, asset allocation, and portfolio of stocks. These factors can result in varying degrees of risk.
It’s essential to research and choose ELSS funds that align with your risk tolerance and financial goals.
Expected Returns from ELSS Investments
- Historical Performance
ELSS funds have delivered attractive returns over the long term. However, past performance is not indicative of future results.
Investors should consider the historical performance of specific ELSS funds and the overall market conditions before making investment decisions.
- Market Conditions
The returns from ELSS investments are influenced by the performance of the equity market.
Historically, equities have provided higher returns compared to other asset classes like fixed income and real estate. However, they also come with higher volatility.
- Investment Horizon
ELSS is best suited for investors with a long-term investment horizon of at least 5-7 years or more.
Over a longer period, the compounding effect can significantly boost returns.
- Fund Selection
The choice of ELSS fund plays a crucial role in determining returns. Different funds may have varying levels of risk and return potential.
Diversifying your ELSS investments across multiple funds or asset management companies can help spread risk.
- SIP vs. Lump Sum
Systematic Investment Plans (SIPs) can help reduce the impact of market volatility by spreading investments over time.
Lump-sum investments may yield higher returns if timed well, but they come with higher risk.
Tips for Maximising ELSS Returns
- Diversify Your Portfolio
Consider diversifying your ELSS investments across multiple funds to reduce risk. Diversification can help mitigate the impact of poor performance by a single fund.
- Regular Monitoring
Keep track of your ELSS investments and the performance of the underlying funds.
If a fund consistently underperforms or no longer aligns with your goals, consider switching to a better-performing option.
- Stay Invested for the Long Term
ELSS is designed for long-term wealth creation. Avoid frequent redemptions and stay invested to harness the power of compounding.
- Plan Your Tax Savings
ELSS should be a part of your overall tax-saving strategy. Consider your financial goals and tax-saving needs when allocating investments.
- Consult a Financial Advisor
If you are unsure about ELSS investments or their suitability for your financial plan, seek advice from a certified financial advisor.
Conclusion
There is no doubt that Equity-Linked Savings Schemes (ELSS) offer a unique combination of tax benefits and wealth creation potential.
Even though they come with risks associated with the volatility of the market, investors with a long-term perspective can potentially benefit from the higher returns offered by stocks.
It is crucial that you choose the right ELSS funds, diversify your portfolio, and remain invested if you want to maximise the returns while enjoying the tax benefits that this investment offers.
To ensure that your ELSS investments are aligned with your financial goals and risk tolerance, make sure that you consult with a financial advisor. The ELSS calculator online tool is very helpful when it comes to investment and risk related to ELSS.