For those looking to invest for long-term goals and also save tax at the same time, ELSS may be the right choice.
Tax saving is integral to efficient financial planning. And, for those looking to invest for long-term goals and also save tax at the same time, ELSS is the right choice. Let us discuss how to invest in it through SIPs:
Why invest in ELSS?
ELSS is an open-ended equity mutual fund that offers tax saving, along with an opportunity to grow your money over a period of time. It outperforms other options with lowest lock-in period and higher returns – ELSS involves a lock-in period of just 3 years, which is the lowest amongst other investment options such as PPF (15 years), Tax-saver FD, ULIP and NSC (5 years each).
It has comfortably beaten its peers in terms of returns as well, by providing up to 23% returns (5 year period). In comparison, other investment options have provided far lower returns, with PPF and NSC currently clocking 7.6%, ULIPs up to 17% (5 year) and tax saving FD providing just 6-8% returns.
Tax deductions available with ELSS
Under Section 80C of the Income Tax Act, ELSS investors are eligible to claim deductions up to Rs 1.5 lakh p.a. When you invest in ELSS through SIPs, the maximum deduction which you can claim, irrespective of the frequency of SIPs in that year, is Rs.1.5 lakh. For higher tax brackets, tax savings can even up to Rs 45,000 (for the highest tax bracket of 30%).
Keep in mind the following while availing ELSS benefits through SIPs:
1. Avoid last-minute investment:
Erratic investment and tax planning strategy increases chances of committing mistakes and at times may even lead to financial loss. Many investors commit the mistake of making last-minute investment in order to save tax. Such actions may put you at risk of not getting tax benefits owing to multiple factors such as failure to submit investment proofs on time or delay in payment clearance etc. In addition to this, you can also end up parking your money in a wrong product in a hurry.
Hence, you must always time your investment in order to make the most of the benefits offered and earn expected returns.
2. Don’t redeem as soon as the lock-in period ends
Since ELSS are equity mutual funds suitable for fulfilling long-term goals with investment horizon of at least 5 years, redeeming your money as soon as the lock-in period lapses wouldn’t allow the investment enough time to garner optimum returns. However, in case your scheme has been consistently under performing as compared to its benchmarks and peer schemes, you may consider exiting.
3. Avoid the dividend trap
This involves distribution of profit gained by the scheme amongst investors in the form of dividends. This distribution can be performed quarterly, half yearly or annually. What most investors fail to realize is that the dividend which is distributed to them is paid out of their own investment amount. Dividend option is largely suited to investors requiring periodic income. However, to achieve specific financial goals linked to your investments, you may consider opting for growth option, wherein the scheme’s profits are reinvested. Such reinvestment assists in creating wealth, since the scheme’s NAV rises upon gaining profit.
4. Tax saving should be the primary but not sole purpose of investing
Before investing in ELSS, investors must make sure they have tied specific financial goals to their investments. Failure to do so deprives your investments of a specific direction and puts their motive in jeopardy. Even though ELSS investment offers tax reliefs under Section 80C, investors must make sure tax saving isn’t the sole purpose of their investment. Tax saving should be the primary but not the sole purpose for ELSS investments, and the objective of wealth creation (for fulfillment of long term goals) should be given equal weightage. Moreover, while choosing ELSS as your tax-saving instrument, always keep in mind the risk, lock-in period, returns etc. involved. The overall benefits offered by ELSS largely outweigh those of PPFs, FDs, NSC etc.
5. Whether to invest in ELSS through SIPs or Lump sum?
Investors can either invest through Systematic investment plans (SIPs) or lump sum investments. Although the decision would rely upon factors such as investor’s financial capacity, investment horizon, market knowledge etc., the SIP mode is more popular and reliable. By choosing to invest through SIPs (whether monthly, quarterly etc.), the concept of rupee cost averaging assists in reducing the risk of market timing. This concept averages out the cost at which the mutual fund units are bought, therefore eliminating the need to time the SIPs. On the other hand, when you invest in lump sum, the risk of entering the market at the wrong time would result in erosion of your money when the markets fall sharply.
(By Manish Kothari, Head of Mutual Funds, Paisabazaar.com)
(Disclaimer: These are the personal views of the author of this article. Readers are advised to consult their financial planner before investing in ELSS)