Equity-linked savings schemes (ELSS) are tax-saving financial instruments and offer tax benefits under section 80C of the Income Tax (IT) Act. Such funds invest a majority of the corpus in equities to deliver capital appreciation.

ELSS is one of the most popular instruments for saving on taxes. With its impeccable track record of beating inflation hands down to its lesser lock-in period (of three years), ELSS as a savings instrument has scored over PPF, Bank fixed deposits and other tax-saving instruments. However, investors need to guard themselves against some common mistakes committed while investing into ELSS.

Section 80C of the Indian Income Tax Act, 1961, has several tax saving instruments, where investors, depending on their investment objective, risk appetite and investment horizon, can invest (if they want to) and claim tax deductions of up to Rs. 1.5 lakhs. Equity Linked Saving Scheme (ELSS) is one such tax saving instrument that falls under Section 80C, in which investors may consider investing. Investors, if they wish to, can save tax up to Rs. 1,50,000 annually by investing in ELSS funds and claim tax deductions to reduce their tax liability. ELSS funds come with a mandatory lock-in of three years, which means ELSS holders need to hold on to their fund for a minimum period of three years.

Benefits of ELSS Mutual Funds

The benefits of investing in an ELSS mutual fund are:

  1. Tax Saving – This is indeed the primary benefit of investing in equity linked savings scheme plan. An amount of upto ₹1.5 lakhs is available for tax deduction per financial year under Section 80C of the Income tax Act, 1961. An ELSS mutual fund is the only mutual fund where you can claim tax deductions.
  2. Lock-in Period – ELSS mutual funds come with a mandatory lock-in period of 3 years in comparison to 5 years or more with respect to other tax saving instruments. PPF comes with a lock-in period of 15 years. Also, an ELSS mutual fund provides the highest returns with the lowest lock-in period.
  3. Long Term Capital Gains Tax – Returns in an ELSS mutual fund post the three year mark are considered as long term gains. Gains above ₹1 lakh are taxed at the rate of 10% under LTCG tax.
  4. Compounding – When you stay invested in an ELSS mutual fund for a period of 5-7 years, not only are you inculcating a disciplined habit of savings, your investment is also subject to the power of compounding.
  5. Higher Returns – ELSS mutual fund invests primarily in equity funds. Equity funds have a higher rate of return (15%-20%) in comparison to other tax saving options (7%-10%).

8 Mistakes to Avoid While Investing In ELSS

Here are the 8 common mistakes that investors make: 

1. Timing the Market

It is very difficult to time the market even for seasoned investors. Stock markets are exposed to a high uncertainty that makes it difficult to predict trends, which makes market timing almost impossible. Therefore, it is recommended you identify funds that are performing well and invest. It is important that you stay invested for a while to ride through market ups and downs. One option is to start a systematic investment plan (SIP). Under this plan, a specified amount is invested in your chosen funds at regular intervals. Therefore, when the market is up, lesser units are purchased and vice versa.

2. Redeeming immediately after Lock-In Period

It is important you remain invested in equity products for at least five to seven years. You must avoid redeeming your ELSS investments immediately after the end of the lock-in period to maximize your returns. Rupee cost averaging and compounding in the long-term deliver higher returns and help you achieve long-term financial goals. It is possible you will also switch from one fund to another at the end of the lock-in period. However, if the fund continues to perform well, there is no reason to move out and invest in another ELSS plan. On the other hand, if the fund is not performing even when market conditions are favorable, switching to another scheme may be beneficial.

3. Lump Sum Investing 

Investing in lump sum at the last month of the financial year – like my friend – might not be the best way. Rupee cost averaging through a SIP (Systematic Investment Plan) ensures you average out your unit cost through the ups and downs of the market. If you plan to invest Rs 1.5 lakh into ELSS, SIP it every month for Rs 12,500.

4. Never late is better

A common observation is that the investors invest in ELSS only towards the end of the financial year when they have to submit their investment proofs to save tax. This is nothing but last-minute rush. An ill-strategy like this one can force many investors to invest a lump-sum amount in tax-saving instruments that may not be the best suited for them leading to cash crunch. Hence it’s wise to start your investment in ELSS at the beginning of the financial year thorough SIP. Thus you could enjoy various benefits of SIP such as disciplined investing, power of compounding, rupee cost average, besides tax benefits. After all, ‘early to rise makes one wealthy and wise’

5. Avoid last minute Rush

Some investors, due to lack of adequate knowledge, turn to tax saving investment schemes like ELSS at the last moment. The problem here is that rushing towards ELSS investment at the final hour may force investors to invest in an ELSS fund or any tax saving instrument through a lump sum. Paying the entire investment amount at the beginning of the investment cycle may not only result in cash crunch but may also refrain investors from making the most out of SIP. Systematic Investment Plan or SIP is a systematic approach where investors can decide when and how much amount to direct towards their investment. All investors need to do is instruct their bank, and a predetermined amount will be deducted from their savings account and directed towards their ELSS investment on a predetermined date every month. But if they invest at the last minute, they might not be able to make the most out of SIP benefits like the rupee cost averaging

6. Loving Large Investments

The asset size of a fund can be large for many reasons. If it is among the best performing, more and more investors invest into it making it bigger in the process. And also as its NAV appreciate, its size increases. Moreover, big-sized funds give comfort to its fund managers to manage the fund without worries of redemption by some big ticket investors. However, becoming too large has its issues. There are instances where a midcap fund has closed for further subscription due to lack of investment opportunities. A Very large ELSS fund in turn could essentially become a large cap fund. This in turn could mean losing out on midcap opportunities.

7. Not comprehending Fund Category

Asset management companies (AMCs) offer ELSS mutual funds based on large, medium, and small cap. Therefore, the risks and returns of each scheme vary. It is crucial you understand your risk appetite to ensure you make the right fund choice. Furthermore, considering only the returns on investment without understanding their risk appetite and funds’ investment philosophies is not advisable.

8. Investing only to Save Tax

It is possible that you consider ELSS investments only as a tool to reduce your tax liability. However, you need to completely analyze the different options to understand risk, lock-in period, and returns. Like all other types of investments, making an informed and well thought out decision is crucial.

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