Financial instruments which can help save on taxes are always in demand. An increase in wealth and a reduction in taxes is the dream for any investor. Add to it the possibility of high returns that comes with equity investing, and you have an attractive proposition. It is the proposition that makes an Equity Linked Savings Scheme (ELSS) popular.
An ELSS plan is a mutual fund scheme that invests in stocks. This category of equity funds comes with an added benefit of tax savings under section 80C of the Income Tax Act, 1961. As defined by SEBI – “Minimum investment in equity & equity related instruments - 80% of total assets. An open-ended equity-linked saving scheme with a statutory lock-in of 3 years and tax benefit.”
Under section 80C of the Income Tax Act, 1961, the total amount that is tax-deductible is ₹1.5 lakh. This entire limit can be exhausted by investing in an ELSS plan. There is no upper limit of investment in these funds. But any amount over the aforesaid limit will not be tax-deductible from the Total taxable Income.
The possibility that these funds can do better than other tax savings options make them a potent and popular instrument. But there are a few misunderstandings that are associated with ELSS funds as well. Let’s see and clear four of them.
Reinvesting in one fund over and over
Many investors are under the impression that all their investments in ELSS are pumped into one scheme. However, it isn’t true. Like mutual funds, ELSS also gives you the option to invest your money in different types of schemes. You can invest in any number of schemes that you want. Generally, it is better to diversify your funds in schemes that have different risk parameters. However, if you want to invest your entire funds in one ELSS plan, keep reviewing your fund so that you’re invested in the best one with the best returns and minimal expense ratio.
Cycling through instead of adding to investments
Some people just keep recycling their ELSS investment, i.e., once their lock-in period expires in 3 years, they redeem their investment and use that money to reinvest in the same or other funds. In this way, they do not need to make any additional investment for saving taxes. But this is a short-sighted strategy, as ELSS is not just a tax-saving instrument but a great way to build wealth as well. Not using it to build yourself a wealth corpus is limiting yourself from availing all the benefits it has to offer.
Do not Sell off the investment after lock-in expiry – Build wealth
Some investors use ELSS funds purely for tax saving purposes, despite the fact that the investment instrument has so much to offer. Among tax saving options, ELSS funds have the shortest lock-in of 3 years. But that does not mean that you have to sell the fund after the lock-in ends. It is especially true if it is performing well. Eventually, the idea is to grow your wealth. And if a good ELSS plan is helping you do that, there is no reason to sell off that fund after lock-in expires.
Lock-in Applied as FIFO (First in First Out)
ELSS funds not only help you save on taxes but can also be an excellent instrument to multiply your money. Because of the lock-in, you get to see how they perform in the long run, unlike other categories of equity funds in which unfavourable market movement may force you to exit the fund quickly. However, be mindful that the SIP you have done today will be eligible for redemption only after its complete cycle of 3 years. The ones done earlier will get redeemed as per their cycle of three years. Thus, the first-in-first-out method follows in ELSS.
Therefore, while ELSS is a simple wealth creation tool, you can make it into an effective one by ensuring you do not fall prey to these myths.
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