Equity linked saving schemes are a kind of mutual funds like diversified equity funds with Tax benefits. It is just like other tax saving instruments like National Savings Certificate and Public Provident Fund. Main advantage with ELSS is lock-in period is only 3 years while for NSC it is 6 years and for PPF it is 15 years. At the same time risk factor is high in ELSS.
As per Income Tax act 80c investment up to Rs 1,00,000 are eligible for deduction from the gross total income hence reducing the total taxable income. For example if your total annual income is Rs 3,00,000 and you invest Rs 1,00,000 in ELSS then your taxable income will become Rs 2,00,000.
Previously there was an upper limit for investing in tax saving instruments like ELSS of 5,00,000. Only individuals with less than 5,00,000 annual income are allowed to invest in tax saving instruments. But last year financial budget removed this restriction and now any individual can invest in ELSS irrespective of their income level.
Advantages of ELSS over NSC and PPF
- 1. Main advantage of ELSS is its short lock-in period. Maturity period of NSC is 6 years and PPF is 15 years.
- 2. Since it is an equity linked scheme earning potential is very high.
- 3. Investor can opt for dividend option and get some gains during the lock-in period
- 4. Investor can opt for Systematic Investment Plan
- 5. Some ELSS schemes also offer personal accident death cover insurance
- 6. Provides 30 to 40% returns compared to 8% in NSC and PPF
Disadvantages of ELSS
- 1. Risk factor is high compared to NSC and PPF
- 2. Premature withdrawal is not allowed but it is allowed in other instruments in some specific conditions.
Diversified Equity Schemes and ELSS
Both Equity linked saving scheme and diversified equity scheme operates in same way. Both are high return and high risk schemes. But there is a 3 year lock in period of ELSS and it provides tax benefits too.
Systematic Investment Plan
Best way to invest in ELSS is through Systematic Investment Plan(SIP). With SIP you can invest a small amount every month for a specific time period. With SIP investor can take advantage of fluctuations in the stock market. So investor will get more units when the market is down and get less units when the market is up. For eg if you are investing Rs 1000 every month and you will get 100 units for when Net Asset Value (NAV) is 10 and will get 50 units when NAV is 20. So investing a fixed sum regularly helps to cover the market fluctuations by rupee costs averaging. Also most of the Asset Management Companies (AMC) charges less entry load for SIP compared to normal purchase.