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Business News/ Mutual Funds / How does investing in ELSS funds help you save on taxes year after year?

How does investing in ELSS funds help you save on taxes year after year?

The Income Tax Act of 1961, under Section 80C, enables taxpayers to avail a deduction of up to ₹150,000 from their taxable incomes by investing in specific eligible instruments, including ELSS funds.

Investing in ELSS funds serves best to investors looking to save on taxes while creating wealth too.Premium
Investing in ELSS funds serves best to investors looking to save on taxes while creating wealth too.

As the financial year draws to a close, maximizing tax benefits through Section 80C deductions becomes essential for numerous taxpayers. It serves as an excellent method to decrease your taxable income and potentially minimize your tax obligations. These investments can fall into either non-market-linked or market-linked categories. The former pose no risk, while the latter may expose investors to fluctuations associated with market movements, experiencing both highs and lows.

Numerous individuals express apprehensions regarding investing in market-linked tax-saving instruments such as equity-linked savings schemes (ELSS). It’s a legitimate concern, as these instruments present a distinctive combination of tax advantages and returns linked to the market, which may appear risky to some.

Breaking down the rationale behind investing in ELSS is crucial to addressing these concerns.

Tax benefits: The substantial allure of ELSS for numerous investors lies in its tax benefits. The capacity to deduct up to Rs. 1.5 lakh from your taxable income through Section 80C can markedly alleviate your tax obligations, particularly beneficial for individuals in higher tax brackets.

The deduction applies to the entire invested amount, not just the profits, making ELSS even more appealing compared to other tax-saving instruments where the deduction may be restricted to the principal amount or interest earned.

To claim the deduction, the investment must be made within the financial year. Therefore, if you intend to invest in ELSS for tax benefits, ensure you do so before the end of March.

The ELSS funds have a lock-in period of three years, preventing redemption before the period concludes. However, investing through systematic investment plans (SIPs) allows you to spread out your investment, potentially mitigating market volatility through averaging.

Higher return potential: Another significant allure for investors is the potential for high returns offered by ELSS. In contrast to fixed-income instruments such as PPF or NPS, ELSS invests in equities, which have a historical track record of delivering superior returns over the long term.

The longer your investment remains in equities, the more potent the impact of compounding returns becomes. Even minor variations in annual returns can result in substantial differences in wealth accumulation over time. For instance, an investment of 1 lakh growing at a 10% annual rate for 20 years would reach approximately 6.71 lakh, whereas the same investment in a 7% fixed-income instrument would amount to around 3.99 lakh.

ELSS is better suited for investors with a greater risk appetite and a more extended investment horizon, preferably five years or beyond. If you anticipate needing your funds in the near future, ELSS may not be the most suitable option due to its imposed lock-in period.

Lock-in period for long-term returns: The pivotal three-year lock-in period of ELSS plays a crucial role in fostering a long-term investment mindset, essential for several reasons. The power of compounding has the potential to significantly enhance wealth over time. Prolonged investment periods enable the reinvestment of returns, generating additional returns and fostering exponential growth. ELSS promotes this by discouraging short-term fluctuations and emphasizing a commitment to long-term gains.

Stock markets frequently encounter short-term downturns and fluctuations. The three-year lock-in period serves as a safeguard, preventing investors from succumbing to panic and selling their investments during these market downturns. By maintaining a long-term investment perspective, investors provide the market with the necessary time to recover, potentially resulting in improved returns.

The lock-in period contributes to instilling discipline and consistency in your investment strategy. Consistent investments through SIPs, for instance, enable the gradual accumulation of funds over time, smoothing out market fluctuations through a systematic approach. This consistent methodology often proves more effective than sporadic or emotionally driven investment decisions.

Engaging in regular investments over a three-year period helps cultivate a habit of long-term investing, and this habit remains valuable even after the lock-in period concludes. The positive experience and understanding of market cycles acquired during this time may increase the likelihood of continuing to invest in equities.

Diversification: Diversification stands as a fundamental principle in successful investing, and ELSS plays a pivotal role in achieving it for various reasons. Traditional fixed-income instruments such as bank deposits and bonds provide predictability and stability, but their potential returns generally fall below those of equities. By investing in equities, ELSS introduces exposure to a different asset class with the potential for higher long-term returns. This diversification serves to decrease overall portfolio risk and enhance risk-adjusted returns.

Distinct asset classes respond differently to market fluctuations. In times when bonds underperform, equities may excel, and vice versa. Having investments in both allows for potential mitigation of the impact of downturns in any single asset class, proving particularly valuable during periods of economic uncertainty or market volatility.

While equities tend to exhibit greater volatility than fixed-income instruments, they also offer the prospect of higher long-term growth. ELSS enables the allocation of a portion of your portfolio to equities while maintaining a balanced exposure to fixed-income assets. This equilibrium aligns with your individual risk tolerance and ensures your investment strategy aligns with your financial goals.

Versatility and options: The strength of the ELSS category lies in its versatility and array of choices. Within the ELSS category, numerous funds exhibit diverse investment focuses and risk profiles. You have the option to select funds concentrating on large-cap, mid-cap, or small-cap stocks, as well as those adhering to specific investment themes. By thoughtfully considering these factors and utilizing the varied options within ELSS, you can construct a personalized investment strategy that aligns with your risk tolerance, financial objectives, and individual values.

ELSS stands out as a flexible and beneficial choice for long-term investors aiming to maximize tax savings and potentially grow their wealth. Investing in ELSS not only aids in tax reduction but also fosters wealth accumulation over an extended period, especially suitable for investors with a high-risk appetite. Additionally, ELSS is highly liquid and ranks among the most tax-efficient investment options available under Section 80C. Ultimately, ELSS provides greater convenience and flexibility compared to other 80C investment alternatives.


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Published: 25 Jan 2024, 10:32 AM IST
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