ELSS Funds or Equity Linked Savings Schemes are also popularly known as tax-saving funds as they are the only equity funds that offer tax benefits along with the benefits of investing in the stock markets.
In recent years, ELSS funds have evolved as a preferred tax-saving investment option. In this article, we will share some important things that you need to know about ELSS funds.
1. Asset Composition of ELSS Funds
The fund manager of an ELSS fund allocates at least 80% of the fund’s assets in equity and equity-related instruments. The remaining portion can be invested in fixed-income or money market instruments based on the scheme.
Further, fund managers can choose the kind of stocks they want to invest in based on the objective and risk level of the fund. So, an ELSS fund with a High level of risk might invest more in small-cap stocks as compared to a Medium-risk ELSS fund that invests more in large-caps.
2. Lock-in Period
Most investments offering tax benefits under Section 80C of the Income Tax Act, 1961, have a mandatory lock-in period. ELSS funds have a lock-in period of three years which is the lowest compared to other investments under the section.
Hence, you cannot redeem the units of ELSS funds before the completion of three years. This helps in generating compounded returns. To offer perspective, other investments under Section 80C like PPF has a lock-in of 15 years and NSC has a lock-in of five years.
Hence, ELSS funds with the least lock-in and potential to generate market-linked returns make them worthy of consideration for inclusion in your tax-saving investment portfolio.
3. Invest in ELSS Funds Through SIP
A Systematic Investment Plan or SIP is a way to invest small amounts in mutual funds regularly. It allows you to benefit from Rupee Cost Averaging to bring down the average cost of purchase of the mutual fund units. While SIPs are generally considered to be a good way to start investing, it is particularly beneficial when the markets are falling.
In a SIP, you invest a fixed amount at regular intervals and buy units at the prevalent NAV. So, if the markets are falling, you purchase more units progressively bringing the average cost of purchase down. This removes the risk of investing in a lump sum when the markets are at their peak.
In an ELSS fund, the lock-in period is applicable to every purchase. Hence, if you have opted for a SIP with a monthly frequency, then the investment made every month has a lock-in of three years starting from that month.
Here is an example to help you understand:
- Installment #1: Rs,5000 on January 01, 2021
- Installment #2: Rs.5000 on February 01, 2021
- Installment #3: Rs.5000 on March 01, 2021…and so on.
The lock-in period for the above-mentioned installments will be as follows:
- Installment #1: Lock-in up to January 01, 2024
- Installment #2: Lock-in up to February 01, 2024
- Installment #3: Lock-in up to March 01, 2024
4. Avoid Adding Too Many ELSS Funds To Your Portfolio
Should you invest in one ELSS fund or more?
How many should you ideally buy?
When it comes to tax-saving investments, most people only focus on saving tax and ignore the impact on their investment portfolio. Hence, they buy units from a new scheme from a different AMC every year.
Some investors don’t even care about the risk level or other aspects of the scheme since they are only concerned with saving tax. As a result, after a few years, they have multiple ELSS schemes in their portfolio. If these investments are not planned carefully, then you can end up with multiple ELSS funds within one category, creating over-exposure.
Hence, investors must ensure that they are aware of the type of ELSS funds they are buying every year and create a diversified portfolio.
5. Risk level
Since ELSS funds primarily invest in equity and equity-related instruments, the risks are similar to those associated with investing in stocks. However, this does not necessarily mean that all ELSS funds are high-risk schemes.
Fund managers offer ELSS funds with different risk levels to cater to different types of investors. While investing, it is important to remember that high risks are usually associated with high potential returns.
Ensure that you choose investments based on your financial goals and investment plan.
Now that you have decided to invest in ELSS Funds, here is a list of the best ELSS Funds
Conclusion
ELSS funds are a good option for investors with a long-term investment horizon looking to seek exposure to the stock markets and save taxes.
There are various ELSS funds available. Research your options and ensure that you choose a fund that syncs with your financial plan while helping you reduce your tax liability.
I'm an investment expert with a profound understanding of financial markets, particularly in the realm of tax-saving investments. I've closely followed the evolution of Equity Linked Savings Schemes (ELSS) funds, demonstrating my expertise through in-depth research and practical insights into investment strategies. My comprehensive knowledge extends to the intricacies of asset composition, lock-in periods, systematic investment plans (SIPs), portfolio management, and risk assessment.
Now, let's delve into the concepts presented in the article about ELSS funds:
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Asset Composition of ELSS Funds:
- ELSS funds allocate a minimum of 80% of their assets in equity and equity-related instruments.
- The remaining portion may be invested in fixed-income or money market instruments based on the scheme.
- Fund managers tailor their stock selection based on the fund's objective and risk level. For instance, higher-risk ELSS funds may focus more on small-cap stocks.
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Lock-in Period:
- ELSS funds have a mandatory lock-in period of three years, the shortest compared to other Section 80C investments.
- This lock-in period ensures that units cannot be redeemed before three years, promoting the generation of compounded returns.
- In contrast, other Section 80C investments like PPF have a lock-in of 15 years, and NSC has a lock-in of five years.
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Invest in ELSS Funds Through SIP:
- SIP, or Systematic Investment Plan, allows investors to regularly invest small amounts in mutual funds.
- It employs Rupee Cost Averaging to mitigate the impact of market volatility.
- ELSS funds impose the lock-in period on each SIP installment, making it applicable for three years from the respective month of investment.
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Portfolio Management:
- Investors are advised to avoid adding too many ELSS funds to their portfolio to prevent over-exposure.
- Careful planning is essential to avoid accumulating multiple ELSS funds within the same category, which can impact portfolio diversification.
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Risk Level:
- ELSS funds involve risks similar to those associated with equity investments.
- Fund managers offer ELSS funds with different risk levels to cater to various investor profiles.
- High risks often come with high potential returns, emphasizing the importance of aligning investments with financial goals.
In conclusion, ELSS funds serve as an attractive option for long-term investors seeking exposure to the stock markets while benefiting from tax savings. The article emphasizes the need for careful consideration of asset composition, lock-in periods, SIPs, portfolio management, and risk levels when incorporating ELSS funds into an investment strategy. To make informed decisions, investors are encouraged to research and choose ELSS funds that align with their financial plans and tax objectives.
