ELSS vs SIP: Key Differences You Need to Know

Summary 

ELSS and SIP are popular investment options but are often misunderstood. ELSS is a tax-saving mutual fund scheme with long-term growth potential. SIP is a way to invest in mutual funds regularly, offering convenience, flexibility, and rupee cost averaging. This article will shed light on the difference between ELSS and SIP.

Being two of the most common mutual fund terms that investors come across, it is natural for novice investors to compare SIP (Systematic Investment Plan) and ELSS (Equity Linked Savings Scheme). However, a deeper dive into their definitions reveals major differences between these two. 

In the following sections, we are going to investigate the fundamentals of ELSS and SIP to help you make informed investment decisions to achieve your financial goals.

Decoding ELSS

ELSS is a popular tax-saving investment option under Section 80C of the Income Tax Act, with the shortest lock-in period of three years among tax-saving options. Moreover, in ELSS 80% of investment needs to be parked in stocks according to the Ministry of Finance notification of 2005.  

It combines tax benefits upto INR 1,50,000 with opportunities for wealth growth through stock market investments, providing returns that beat inflation making it ideal for long-term financial planning.

Decoding SIP

SIP is an easy way of investing in mutual funds that allow investors to regularly invest small amounts at chosen intervals, be it weekly, monthly, quarterly, or bi-annually. While investors determine the SIP amount, it cannot be less than the fund house's minimum investible amount. This method offers comfort and convenience to investors, as it doesn't require a large lump sum investment and provides a systematic approach to investing in mutual funds. Moreover, SIP offers hassle-free investment schedule to the investor. An investor can simply instruct his/her bank to debit the SIP investment amount at chosen intervals through standing instructions. 

Investing in a mutual fund through SIP enables investors to grow their wealth gradually over time. Investors can also leverage the advantage of compound interest. This means that as their money generates returns, those gains are reinvested, leading to the growth of the total amount by earning more returns.

SIP vs ELSS - Top 5 differences  

Although both are popular investment options, the difference between ELSS and SIP lies in their structure and flexibility. ELSS is an investment option in itself, while SIP is a mode of investing in ELSS or any other mutual funds. Here is a breakdown of their key differences:

Investment modification 

If you think the market will change in the next few months, you might want to switch your investments to better options. ELSS funds do not permit access to your investment before the three-year lock-in period. But if you haven’t invested in any ELSS funds, it is easy to switch your SIP investments. Most mutual fund companies offer two free transfers per year. Thus, when the capital market experiences volatility, investors often move from equity funds to debt funds and vice versa.

As a financial vehicle

While SIP is not an investment vehicle in itself, it allows regular investments into multiple mutual funds, including equity, hybrid, debt, liquid, capital protection, and even fund of funds. ELSS, on the other hand, offers tax benefits but limits investment flexibility due to its lock-in period. Because of this, it makes sense to invest part of your portfolio in equity funds for robust capital growth and part in debt funds for consistent growth and capital protection.

Lock-in period

ELSS mutual funds come with a mandatory three-year lock-in period, whereas SIP investments typically offer greater flexibility. However, for certain specific schemes, mutual fund institutions may impose exit loads for early withdrawals. On the other hand, ELSS investments cannot be withdrawn under any circumstances before the three-year lock-in period ends.

In terms of lock-in duration, SIP offers more flexibility compared to ELSS, but this flexibility may come at the cost of tax deductions. If an investor chooses to shorten the lock-in period by opting for a non-ELSS SIP, they will need to forgo the tax benefits associated with ELSS investments.

Tax benefits

ELSS mutual funds provide tax benefits of up to INR 1,50,000 per annum from your taxable income under section 80C of the Income Tax Act. On the other hand, one can avoid taxes only by investing in ELSS through SIP. 

Rupee cost averaging

Upon investing a fixed amount regularly, SIPs allow investors to average their purchase price, minimising the impact of market fluctuations. This also enables investors to potentially acquire more units when the net asset value (NAV) is lower. This advantage extends to ELSS funds only when invested in them through SIPs.

In a nutshell

ELSS and SIP are two distinct investment options that work well together but cannot be compared. Investing in ELSS through SIPs is a convenient approach to tax savings that eliminates the need for last-minute maneuvers to lessen tax burdens. SIPs promote disciplined saving and have the potential to enhance returns on ELSS funds through rupee cost averaging. Strategically combining both methods can empower investors to optimise their investment approach for maximum benefits. Investments in ELSS and SIP have their own pros and cons. It is advisable to gather thorough knowledge of them and seek expert advice before making your investments.