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Steering Clear of Pitfalls: Top 4 Mistakes to Avoid in ELSS Investment

Triston Martin

Dec 12, 2023

The Equity Linked Savings Scheme (ELSS), a form of Equity Mutual Fund, is a popular tax-saving investment in India. ELSS AUM exceeded Rs. 1.35 lakh crore, indicating rising interest. This number is expected to rise. Despite this enthusiasm, many investors see ELSS funds as fixed-return securities, restricting their potential returns. Knowing the ELSS meaning and unique nature and investing strategically helps unlock its tax-saving potential, giving investors financial security and development. Here are a few common mistakes you must avoid in ELSS investments:

Lumpsum Year-End Investments

Many tax-saving investors pay a fixed fee to Equity Linked Savings Scheme (ELSS) Mutual Funds at year's end. Because Hanaa ELSS are equity investments, this method may not work as well as it looks. ELSS fund returns depend on market circumstances. Thus, lump sum investment timing is crucial.

ELSS lump sum investors risk entering the market amid adverse conditions, which might lower their profits. The volatility of equity markets might provide suboptimal returns during lump sum investments while the market is high. A Systematic Investment Plan can reduce risk and improve tax-saving investments. Instead of making one lump sum payment, SIPs let individuals contribute regularly throughout the year. This strategy fosters financial discipline and hedges against market volatility.

ELS SIPs let investors make minor, periodic contributions without being excessively exposed to market swings. This methodical technique averages purchase costs over time, lowering market volatility's influence on the investment portfolio. Since investments are made year-round, investors don't need to schedule their equity market participation. SIPs make diversifying assets across market circumstances easier, increasing the likelihood of market benefits. SIP-based ELSS investing strategies provide risk minimization and disciplined and strategic wealth management.

Skipping Scheduled ELSS SP

Your tax-saving investing plan may suffer if you skip scheduled Systematic investing Plans (SIPs) in Equity Linked Savings Scheme (ELSS). ELSS might create wealth through focused, systematic investing, but straying from the plan can negate these gains. Imagine a 10-year Rs. 10,000 monthly SIP in the Axis Long Term Equity Fund from April 2011 to March 2021. If no SIPs were missed, the investment would be Rs. 12 lakh. By April 1, 2021, the fund's corpus will reach Rs. 30.66 lakh with a 17.88% CAGR.

For ten years, let's explore the effects of missing two SIPs in August and September. By skipping 20 SIPs, the investor would have invested Rs. 2 lakh less overall. Beyond the initial investment drop, there are more profound effects. First, skipping Rs. 2 lakh tax-saving investments would raise tax payments by Rs. 60,000 for an investor in the top 30% tax band. This is a financial setback. However, the effects go beyond. Potential profits from missed SIPs also matter. The comparative table shows that investing Rs. 2 lakh less over ten years will yield Rs. 26.03 lakh. The overall corpus would be Rs. 5.30 lakh lower after the investing term.

This large discrepancy emphasizes the need for ELSS SIP compliance. Financial discipline and avoiding skipping payments are essential to maximizing ELSS investments. Equity market wealth is built on compounding and continuous investments. Investors reduce market timing risk and increase long-term tax savings by following the SIP plan. Regular contributions are essential to reaching financial objectives through ELSS mutual funds investing.

Redeeming ELSS Investments

Equity Linked Savings Scheme (ELSS) is appealing for its tax-saving benefits and three-year lock-in period. Investors may redeem their ELSS units immediately once the lock-in period ends, but many make the error of doing so. Despite the ability to exit, investors must realize that ELSS's genuine potential develops over extended periods. Equity investments like ELSS prosper when held for seven years or more. This longer saving time lets investors ride out market cycles and capitalize on stock market gains. The constancy of returns from prominent ELSS Mutual Funds over seven years shows the impact of this long-term approach.

There are five popular ELSS funds' 5-year rolling returns:

  • Quant Tax Plan (ETMONEY Rank: 1): This fund's 7-year returns range from 9.27% to 33.09%, demonstrating its steadiness.
  • DSP Tax Saver Fund (ETMONEY Rank: 2): This fund has strong growth potential over seven years, with returns from 13.41% to 38.41%.
  • Canara Robeco Equity Tax Saver Fund (ETMONEY Rank: 3): This fund consistently delivers 17.03% to 35.14% over seven years.
  • Kotak Tax Saver Fund (ETMONEY Rank: 4): This fund's 19.93% to 41.49% returns demonstrate the wealth-building potential of long-term investments.
  • UTI Long Term Equity Fund (ETMONEY Rank: 5): Despite some consistency issues, this fund yields 16.67% to 29.71%, demonstrating the benefits of a long investing horizon.

These statistics show that these ELSS plans will unlikely provide negative returns over seven years. Moreover, most tax saving Mutual Funds routinely yield 12% to 20% yearly returns. Thus, investors should resist the desire to redeem ELSS meaning units quickly after the lock-in period expires and instead embrace their long-term wealth-building potential.

Choosing IDCW Option

Investors must choose between growth and IDCW (Income Distribution cum Capital Withdrawal) options when picking an Equity Linked Savings Scheme (ELSS) fund. Growth involves reinvesting fund earnings to maximize compounding. However, choosing IDCW entails quarterly distributions, which may provide income throughout the fund's 3-year lock-in. The seeming benefit of fast payments has significant downsides.

IDCW may look enticing for lock-in income, but each dividend lowers unit Net Asset Value (NAV). The drop in NAV reduces compounding, reducing long-term returns. Reinvesting earnings in the growth option maximizes wealth generation by exploiting the compounding impact.

The tax disadvantage of IDCW plans in ELSS funds is also present. IDCW plan payouts are fully taxed at the investor's income tax bracket. IDCW payments might increase by 30% for those with the highest tax rate of 30%. IDCW is less appealing due to its tax effect. Avoid IDCW plans and choose growth to maximize ELSS investments. The growth option boosts compounding and is tax-efficient, supporting ELSS investors' long-term wealth-building goals. Investors may enhance compounding and long-term profits by emphasizing growth.

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