ELSS Risk vs Rewards: A Blog to Demystify Risk and Reward Associated with ELSS

As the Financial year 2020-21 comes to an end, the foremost thing on your mind as a taxpayer must be filing your taxes and ensuring whether you have invested your money in tax-saving instruments over the last year. There are various options to choose from as specified in the Income Tax Act according to your capacity to take a risk.

It is advisable to not defer investing at the last minute, rather be prudent and take the right decision early in the financial year. However, if you are struggling to differentiate between ELSS vs mutual fund, ELSS vs NPS, or ELSS vs SIP in the hurry to file your taxes, chances are that you are not aware of ELSS funds. Lets us take a look at how they can help you create wealth and save tax.

What are ELSS mutual funds?

ELSS is a short term or abbreviation for an Equity-linked savings scheme. These are the only mutual funds that can help you avail of a tax deduction under 80C up to a maximum investment of Rs 1.5 lakh in a financial year. As the name suggests, ELSS funds are diversified mutual funds that invest your capital in equities and securities related to the equity market.

ELSS mutual funds have recently emerged as one of the better return generating investments in the tax-saving category in the past few years. They are purely equity-oriented funds offering you a potentially higher yield as compared to fixed-income tax instruments such as PPF, NSC, tax-saving FDs, etc. However, you need to remember that mutual fund performance is influenced by market movements and hence past performance is not an indicator of returns in the future.

Still, if you are looking to create wealth and enjoy returns on your money that help you beat inflation, equity investments can be a good choice to help you meet your life goals in the long term. With the added benefit of reducing your tax liability, these funds have an upper hand in the battle between the ELSS vs mutual fund from other categories.

How can you invest in ELSS funds?

If you are confused between ELSS Vs SIP, you need to understand that SIP stands for Systematic investment plan. It is a mode of investment in most mutual funds including ELSS, apart from the lump-sum investment. SIPs work just like equated monthly installments or EMIs and allow you to invest in equity markets while taking calculated risks. It also helps you benefit from rupee cost averaging so you purchase more units when the market is low and less when it is high. SIP is the ideal route for wealth creation on a budget.

Advantages of ELSS investment

Now that you know the difference between ELSS Vs SIP, you need to understand how can investing your savings in an ELSS fund be rewarding for you. Here’s how:

1. Lowest lock-in period: If you compare ELSS vs NPS, you will find that while both allow you to save tax, your money is locked in NPS till the age of 60. Public Provident Fund, another safe tax-saving haven, has a lock-in period of 15 years. Of all the available 80C tax-saving investment options, ELSS mutual funds have the shortest lock-in period of just 3 years, thus offering greater liquidity. At the end of 3 years, you may choose to redeem your units partially, fully, or even stay invested for another 2 to 4 years.
2. Gives you exposure to equity markets: If you are starting to invest in equities, ELSS can be your first step to the world of equity markets. These funds are professionally managed and come with a diversified portfolio. You can choose from the various funds in the category following how much equity exposure is suitable for you as per your ability to take a risk. Use the SIP route, to begin with, nominal ELSS investment that saves you the burden of timing the market. Direct investment in the stock market is preferable for those with knowledge of equities as well as a knack for taking calculated risks.
3. Potential Higher Yield:Another point of difference between ELSS vs NPS is the return on capital. NPS returns depend on the mix of equity and debt in various pension schemes and stood between 10%( Scheme C and Scheme G) to 22% (Scheme E) for the last year.  Whereas average ELSS fund returns were as high as 25% with the best performing ELSS mutual fund giving a 60% return and the one at the bottom, 11.5%.

A note of caution

To maximize returns from your ELSS investment, you should also be aware of a few risks associated with it such as:

1. Not choosing the right scheme: When zeroing upon an ELSS fund, look for consistent performance over the years, rather than going by how it has fared in the last year. Also, choose funds in line with your diversification strategy. While some funds may have more large-cap exposure, others might have greater mid-cap allocation. This will help you make an informed choice that blends with your investment principles.
2. Investing for the short-term: Even though ELSS comes with a 3-year lock-in duration, you should stay invested for a longer period. This is because since you are investing in equities, there is bound to be a fluctuation in the net asset value(NAV) of funds which may be a dampener in the short-term. However, in the long run, you will be able to overcome the volatility to enjoy above-average returns.

Conclusion

Investing in ELSS is the smart way to see your hard-earned money grow in the long run. At the same time, ELSS investment gives you the double benefit of relieving your tax burden. A detailed, goal-oriented approach is key to reaping the rewards of the money that you invest in ELSS. Remember to select the right ELSS funds that suit your long-term goals at the beginning of the year and invest regularly to see your wealth grow.