Using SIPs for Equity-Linked Savings Schemes
Equity-linked savings schemes (also known as ELSS) are a type of investment scheme for investing in equities and their related securities to earn from capital appreciation in the long run. This blog has details on why it is a preferred method for many.
Introduction to equity-linked savings schemes
Equity-linked savings schemes (also known as ELSS) are a type of investment scheme for mutual funds that are offered in India. Primarily, these funds invest in equities (stocks) and their related securities to earn from capital appreciation in the long run. These funds are popular because of their potential to provide higher returns in comparison to regular tax-saving investments such as fixed deposits and the Public Provident Fund. They come with the dual benefit of tax savings under Section 80C of the Income Tax Act, 1961 and the opportunity to create wealth.
The following are a few of the main features of ELSS:
- Lock-in period: For ELSS funds, there is a mandatory three-year lock-in period. This implies that once an investment has been made in an ELSS, the money cannot be withdrawn for a minimum of three years. After that period, the investment can be redeemed.
- Tax benefits: Investments in ELSS are eligible under Section 80C of the Income Tax Act for tax deductions. Those who invest in them can claim up to INR 1.5 lakhs in deductions in a financial year. Also, returns from investments in ELSS are tax-free till a certain limit.
- Market-linked returns: ELSS funds make investments primarily in equities. As a result, the returns are affected by market volatility. These funds have the capacity to generate higher returns than fixed-income tax-saving instruments but also have a higher degree of risk.
- Systematic investment plan (SIP): A popular option among investors is to invest in ELSS funds via a lump sum or systematic investment plan (SIP). This enables the investment of a certain amount at fixed intervals, making it simpler to invest in a more disciplined manner.
- Diversification: Usually, ELSS funds diversify the portfolios across a variety of stocks and sectors to reduce exposure to risk. This helps to mitigate the impact of unfavourable performance in any one company or sector.
- No guaranteed returns: Unlike other types of tax-saving options such as PPFs and fixed deposits, there are no guaranteed returns from ELSS funds. The returns are reliant on the underlying equities' performance.
- Redemption: After the lock-in period of three years, investors are able to redeem their ELSS investments. This provides liquidity after the said, enabling investors to either withdraw the entire amount or a portion, as deemed fit.
- Risk and volatility: Because of the exposure to equity exposure, ELSS funds entail a higher degree of risk and are subject to market fluctuations. It's essential for investors to have a long-term investment horizon and tolerance for risk.
How to use SIPs for equity-linked savings schemes:
For most investors, SIPs are the preferred approach for ELSS investments because they are the disciplined and effective way to acquire tax-saving mutual funds. Here are the steps on how it can be done:
- Choose the ELSS Fund: begin by selecting the ELSS fund where you would like to invest. Check for funds that are in alignment with your risk tolerance, financial goals and investment horizon. Analyse the past performance of the fund, the track record of the fund manager and the composition of the portfolio to make an informed decision.
- KYC (know-your-customer) formalities: It is a mandatory requirement to be KYC-compliant to be able to invest in mutual funds in India. The process for KYC is done by providing proof of identity and address to the fund management company/broker or through intermediaries such as registrars and transfer agents.
- Decide on the SIP amount and frequency: Decide on the amount you want to invest. SIPs provide the flexibility to invest a certain amount at fixed intervals (such as monthly, quarterly and annually). The minimum amount depends on the minimum investment requirements of the specific fund.
- Provide bank details: The bank account will need to be linked for automatic debits as per the schedule of the SIP. Most companies make it convenient by offering online services for registering for SIPs.
- SIP duration: Even though ELSS funds come with a mandatory three-year lock-in period, it is possible to continue beyond it for long-term wealth creation. For each SIP installment, the lock-in period, calculated from the date of each installment, is three years.
- Tax benefits: A deduction can be claimed under the IT Act for the amount that has been invested through SIPs in ELSS.
- Monitor and review: It is essential to periodically review the ELSS' performance to increase or decrease the SIP amount, depending on the goals and financial situation.
- Redemption and liquidity: The units can be redeemed after the initial three-year lock-in period for each SIP installment. This provides liquidity while making it possible to claim tax benefits.
The use of SIPs for investments in ELSS helps save taxes, as well as instills financial discipline which can help benefit from the potential wealth-creation of capabilities of equities over the long run. For those who are keen on investing in ELSS, SIPs are without a doubt the preferred way to go about it. However, like other forms of investments, the risks and uncertainties can be dealt with by taking the help of an experienced financial advisor to align the strategy with the overall financial goals and plan.