Equity Linked Savings Scheme (ELSS) is an open ended tax saving scheme that come with a statutory lock in period and tax benefit. As of now, ELSS is the only mutual fund scheme that offers tax benefit and long term capital appreciation. ELSS comes with a mandatory lock in period of 36 months from the date of investment. This means that one cannot redeem or withdraw their ELSS fund units for a minimum period of three years. 

Here’s an example to help investors understand how ELSS works –

Bajaj Bansal is a senior marketing executive with a gross annual salary of Rs. 11.5 lakhs. With that kind of salary, Bajaj finds himself in the 30 percent tax bracket. Upon finding about the benefits about a tax saving scheme like ELSS, Bajaj plans to invest in this tax saver fund. Now according to Section 80C of the Indian Income Tax Act, 1961 a tax paying individual can invest up to Rs. 1.5 lakhs per fiscal year in ELSS and claim tax deductions for the same. By investing in ELSS, Bajaj’s gross taxable income has come down to Rs. 10 lakhs. 

Also, since ELSS is an equity oriented scheme, over the period of three years there is a good chance for the SIP amount to grow and accrue interest in the process.

ELSS may seem like a lucrative option for several taxpayers looking to bring down their tax liability this fiscal year. However, here are some of the things they should keep in mind before investing in ELSS:

Understand your risk appetite – ELSS is a tax saving scheme which predominantly invests in equity and equity related instruments. This makes it an investment product with a high risk profile. Although ELSS carries a high risks rewards ratio, it does not guarantee capital appreciation. One’s profile might even suffer some losses over the short term. Hence, every individual must understand their appetite for risk before investing. 

Choose between SIP and lumpsum investment – There are multiple ways to invest in ELSS scheme. One can either make a onetime lumpsum investment or they can start a SIP in ELSS fund. A Systematic Investment Plan gives investors an opportunity to make small investments at regular intervals. One doesn’t even need to have a large capital to initiate SIP in ELSS funds. SIP investments have several advantages. Investors are allotted units every month depending on the fund’s current NAV (net asset value). SIP investments are also known to benefit from power of compounding. In mutual funds compounding refers to interest earned on the interest earned from the principal investment amount. One can even refer to an online SIP calculator to determine how much money they need to invest at regular intervals in order to save taxes over the long term. 

Investment objective – ELSS aims at generating capital appreciation over the long term and comes with a predetermined lock in period of three years. It is essential for the investor’s investment objective to align with that of the ELSS scheme. The scheme must hold the potential to address the investor’s investment needs. 

Past performance of the ELSS fund – Market regulator SEBI, through its categorization, has managed to bring all similar investment schemes under one umbrella. Investors can now compare the performance of several investment schemes to determine a better performing fund. One must consider a consistent performing ELSS fund rather than opting for a top performing scheme. 

These are some of the common things every ELSS fund investor should keep in mind before investing. Those who are new to tax saving or mutual funds in general should consider consulting a financial advisor.