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Save Taxes And Create Wealth With ELSS Funds
Here are a few things to keep in mind while investing into an ELSS, in order to maximize your chances of wealth creation
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A number of tax saving instruments qualify under Section 80(C). Unfortunately, a number of these instruments do not really have the potential to create wealth for you over the long term. Even your PPF account will grow your money at 8.1% per annum, which is barely sufficient to outpace inflation. There is, however, an excellent investment avenue which allows you to save taxes under Section 80(C), while at the same time providing you with a high chance of capital appreciation.
Equity Linked Savings Schemes
Equity Linked Savings Schemes or "ELSS" funds are a category of equity mutual funds with a 3 year lock in period. They aim to provide you with long term capital appreciation, alongside allowing for a deduction under Section 80(C).
Mr. G. Pradeepkumar, Chief Executive Officer, Union KBC Asset Management Company, firmly believes that ELSS Mutual Funds outscore traditional tax saving instruments on several counts. "Among the available tax saving instruments, ELSS funds, being equity oriented, are better equipped to generate higher capital appreciation over the long term. With the shortest lock in period among tax saving instruments, investment along with gains, if any, under ELSS funds are available for redeployment by the investor after 3 years with nil tax on gains. Also, an investor can opt for dividend option which can give cash flows within the lock in period", he says.
Here are a few things to keep in mind while investing into an ELSS, in order to maximize your chances of wealth creation.
Understand the Risks involved
Understand that unlike many traditional investments, ELSS funds aren't risk free. Their NAV's are linked to stock market movements, and your fund value will fluctuate depending upon how the broader market is faring. "There is a certain level of inherent risk in all equity investments, and ELSS is no exception. In the short term, markets can be volatile and investors may even experience negative returns", cautions Pradeepkumar.
Investing with a clear and thorough understanding of the risks involved will ensure that you've optimized your chances of reaping maximum benefits. The lock in period of 3 years also forcefully protects investors from making rash decisions based upon market volatility.
Three years is minimum - Five is better
While the stipulated lock-in period for an ELSS is 3 years, it's far better to invest in the fund with a time horizon of 5 to 7 years. Sometimes, you might find that you're invested in an ELSS at a high point of the market cycle. In such a situation, 3 years may not suffice as an adequate time horizon.
Pradeepkumar of Union goes a step further and suggests that investors should hold on to their ELSS investment for two economic cycles. "The lock in period in an ELSS fund is of 3 years. However, being an equity fund, it is advisable to hold your investment minimum for two economic cycles. A typical economic cycle usually lasts for 5 years", he advises.
Choose the 'Growth' Option if your Goals are long term
When investing in a Mutual Fund, one has the option of choosing the "Dividend" or "Growth" option. Choosing the dividend option will give you periodic liquidity from your investments (as and when the fund house declares a dividend on your ELSS). However, it will damage the long term appreciation potential by not allowing compounding to work its magic. If Wealth Creation is your goal - opt for the growth option rather than the dividend option.
Rather than make a hurried lump sum investment in an ELSS on March 31st, why not compute the annual gap in your 80(C), divide it into 12 easy instalments, and start a monthly SIP for that amount instead? Not only will it be easier on your pocket, but it'll help absorb some of the risks through rupee cost averaging. Do bear in mind that each SIP tranche is considered an individual, separate purchase and will therefore be locked in for three years from the SIP purchase date.
In the long run, your small monthly SIP can compound into a large fund value while putting your tax savings on auto pilot. Pradeepkumar agrees. "Regular investment through SIP is easier as against lump sum investment at the end of the financial year. Also, the SIP mode gives rupee cost averaging benefit to an investor", he suggests.