Equity Linked Savings Schemes: How to create wealth over long term by investing in ELSS

By Aakash Manghani

Of the various asset classes available to investors for creating wealth over the long term, equity as an asset class stands apart. When compared to other asset classes such as debt, gold, real estate etc, the potential of equity to generate a better real-return over the long term is high. Within the equity asset class, there are several investment options for an investor to choose from and hence selection of the right option is key to utilize the full potential of equities.

Equity linked savings schemes (ELSS) is one such investing option which because of its exposure to equities provides an option to create wealth over the long term. Through ELSS, you too can participate in the growth potential of equities and achieve your long term goals as and when they arise in your life.  Further, there are some unique features of ELSS and let us see how to make it work to one’s advantage: 

Save tax and grow savings

What’s better than saving tax even while you watch your money grow to meet your long term goals. The investment made in ELSS scheme qualifies for tax benefit under section 80C of the Income Tax Act, 1961. You may invest in more than one ELSS but the maximum tax benefit is capped at Rs 1.5 lakh a year. The tax benefit on investment made in ELSS is not only at the initial stage but also available during the exit or redemption of ELSS units. However, unlike in the past, since 2018, the gains above a certain amount in ELSS is subject to tax in the hands of the investors. The long term capital gains tax in equity funds including ELSS is 10 per cent on gains realised above Rs 1 lakh in a financial year. 

Benefit of lock-in period

The amount in ELSS is locked-in for a period of three years including the amount invested through SIPs. Each SIP in ELSS will have a lock-in period of 36 months. Incidentally, among all the tax-saving options under section 80C, ELSS has the shortest lock-in of three years. 

All ELSS funds are pre-dominantly invested in equities which is inherently volatile over short to medium term. However, the lock-in period makes it work to the advantage of an investor. As your investments gets locked-in for at least three years, the temptation to exit based on market conditions does not exist. It also gives the fund manager of the scheme to take aggressive decisions in stock picking for better risk-adjusted returns in the portfolio. 

Once lock-in period ends

After the lock-in period ends, the investment or the fund value is available to you as similar to any other open-ended mutual fund. You may redeem partial units or the entire number of units or may even continue with the investments for a longer duration. Once the lock-in ends, you may continue with the investments by earmarking the funds for your long term goal. Each year, your investment in ELSS up to Rs 1.5 lakh, not only gives you the tax benefit but also helps in accumulating wealth over the long term. 

Performance

The performance of ELSS funds as a category is in line with the other categories such as that of large-cap and mid-cap funds. Over longer time frame, the returns have even been seen to be more than some other categories. BOI AXA Tax Advantage Fund is one of the many ELSS funds that has shown consistent performance over the 1-3-5 year period. The fund is a diversified multi-cap fund having beaten the benchmark comfortably over the long term. In the ELSS category, the fund is in the top quartile with a well-diversified portfolio of stocks.

How to choose ELSS

If your aim is to create wealth by investing in ELSS funds, the selection of the right scheme holds the key. You may diversify across more than one ELSS but instead of choosing the scheme based on recent performance, make the selection based on scheme’s consistent performance over the long term. Also, some ELSS funds may have high exposure to large-cap stocks while others may be allocated more in mid-cap stocks. While selecting ELSS funds, make sure that there is proper diversification across market-cap and industries. If your goal is to create wealth over the long term and also save tax during the journey, ELSS fits the bill provided you are ready to take short-term volatility in your stride. 

(Aakash Manghani is a Fund Manager at BOI Axis MF and the views expressed are his own. Mutual fund investments are subject to market risks, read all scheme related documents carefully.)