Investors prefer ELSS as it is one of the few options under Section 80C of the Income Tax Act, which invests in equity instruments.
Equity Linked Savings Scheme or ELSS is fast emerging as a popular investment to save tax. It helps you get the twin benefits of wealth creation and tax saving in one investment. Investors prefer ELSS as it is one of the few options under Section 80C, which invests in equity instruments.
Equity as an asset class can offer inflation-beating returns over time. For instance, the ELSS category provided average returns of 16% over ten years. What makes ELSS one of the best options to build wealth and save tax?
What is ELSS?
ELSS is a tax-saving mutual fund that invests mainly in equity and equity-related instruments. It qualifies for a tax deduction under Section 80C up to Rs 1.5 lakh per year and has a three year lock-in period.
ELSS is a diversified investment in stocks across sectors and market capitalisation. It aims to maximise investor returns over the long term.
Why is ELSS the best option for wealth creation and tax saving?
ELSS invests at least 80% of total assets in equity and equity-related investments which can offer inflation-beating returns over time. Studies show that equity investments outperform most other asset classes over time. Moreover, ELSS has a tax advantage that helps you save tax and build wealth over time.
ELSS is more liquid than other tax-saving investments under Section 80C as it has the shortest lock-in period of three years. Investors in the highest tax bracket can invest Rs 1.5 lakh per year in ELSS and save up to Rs 46,800. Moreover, it is a tax-efficient investment as long term capital gains (LTCG) up to Rs 1 lakh are tax-free. However, LTCG from ELSS above Rs 1 lakh is taxed at 10% without the indexation benefit.
Experts believe that equity investments will out beat most fixed-income investments over three to five years with stock markets at current levels. Moreover, it is tax-efficient compared to many fixed-income investments except those qualifying for the EEE tax regime.
You must invest in ELSS through the systematic investment plan or the SIP instead of a lump sum. It is a facility offered by mutual funds where you regularly invest small amounts of money in a mutual fund scheme.
SIP encourages disciplined investment where you invest across all stock market levels. It averages out units purchase price over time, called Rupee Cost Averaging. Investing in ELSS through the SIP minimises the impact of market volatility as you avoid timing the stock market.
Investors who stay with equity investments, including ELSS for the long term, benefit from the power of compounding. As equity investors earn a return on the principal amount and the returns made over time, they reach financial goals faster. You must invest in ELSS as early as possible and stay invested for the long term to build wealth while gaining from tax savings.
ELSS is an excellent investment for first-timers in the stock market. It has a mandatory three year lock-in period that encourages you to invest for the long term. Equity investments are volatile over the short run but generate wealth over time. Experts recommend that you stay invested in ELSS for five or more years to maximise your returns.
You must pick an appropriate ELSS based on your risk tolerance as these schemes invest in mid-cap and small-cap stocks. It would help if you chose an ELSS with a lower expense ratio than peers to increase overall returns over time. Select ELSS, which have consistently given higher returns than the benchmark and peers over three to five years. It also helps to check the performance of the ELSS in bear markets. Finally, choose an ELSS that helps you build wealth and look at tax deduction as an additional benefit.
(The author is Founder and CEO at Clear)