Like most investors, you might know about the tax benefits of ELSS funds in old tax regime of Income Tax Act, 1961. But do you also know that these funds come with a 3-year lock-in period? Or that tax deductions are applicable only on the principal investments in an ELSS funds in old tax regime? If not, then you’re not alone.
Many investors overlook these things and much more. That’s why, in this article, we have discussed some of the most common mistake’s investors make while investing in ELSS funds. We’ve also covered solutions for each so you know exactly how to tackle these issues!
Table of Content
What are ELSS Funds?
ELSS or Equity-Linked Savings Schemes are a type of open-ended equity-oriented tax-saving mutual fund scheme that offer tax benefit in old tax regime under section 80C of the Income Tax Act. In fact, they are the only type of mutual fund scheme that’s eligible for tax benefits.
Let’s have a look at the key characteristics and features of ELSS funds:
ELSS funds have to invest at least 80% of their assets into equity and equity-linked instruments. (in accordance with Equity Linked Saving Scheme, 2005 notified by Ministry of Finance).
You can claim an annual deduction of up to Rs. 1.5 Lakhs on the invested principal as ELSS mutual fund tax benefits under the old tax regime.
ELSS funds come with a 3-year lock-in window during which you cannot withdraw your investment.
7 Common Mistakes to Avoid When Investing in ELSS Funds
1. Ignoring the 3-Year Lock-in Period
You might be aware of the mandatory 3-year lock-in window of an ELSS fund, which is also the shortest among all tax-saving 80C instruments. But there’s more to this lock-in period:
If you invest via SIPs, the 3-year lock-in is applicable to each SIP installment separately.
So, if you invest Rs. 5,000 in January, this amount stays locked until January 3 years later and so on.
This means, you won’t be able to withdraw the entire corpus after the completion of 3 years from your 1st SIP Installment.
Solution: Consider planning your ELSS fund investments to line-up with your future milestones to avoid liquidity issues. You may also consider a lump-sum approach if you anticipate needing the corpus after 3 years.
2. Investing in Multiple ELSS Funds
Another common mistake investors make with ELSS funds is investing in multiple schemes from different AMCs. This can create issues for your portfolio because:
Investing in multiple ELSS funds may dilute the diversification of your portfolio since many funds may invest in the same underlying stocks. This can increase portfolio risks and compromise potential returns.
When it comes to ELSS fund tax benefits, you can only claim up to Rs. 1.5 Lakhs in a financial year (cumulative under the 80C limit under old tax regime. So, investing in multiple ELSS funds will not give you extra benefits.
Solution: Do your research well and stick to one ELSS fund instead of adding multiple schemes from different AMCs.
3. Investing Only Rs. 1.5 Lakhs into the Fund
There is a very common misconception among investors that you can invest only up to Rs. 1.5 Lakhs into an ELSS fund. In reality:
There is no upper limit to how much you can invest in an ELSS fund.
You can only claim deductions of up to Rs. 1.5 Lakh on the principal sum under the old tax regime, regardless of how much you invest in the fund.
Solution: Don’t think that you have to restrict yourself to the Rs. 1.5 Lakh limit. Plan your investment based on your risk appetite, goals, and time horizon.
4. Not Understanding the Tax Benefits of ELSS Funds Clearly
Tax benefits of ELSS funds include deductions of up to Rs. 1.5 Lakhs - this is common knowledge. But that’s not all. Investors often forget that:
This tax benefit of ELSS fund is applicable under the broader 80C limit under old tax regime.
It is applied in combination to any other 80C tax-saving investment you have.
Only the principal invested qualifies for tax deductions, not your returns.
The 80C tax benefit is only applicable under the old tax regime.
Solution: If you already have 80C investments, see if there’s actually any room left within the umbrella deduction limit of the section before investing in ELSS funds (if you’re investing primarily for tax benefits). Also consider if you’re filing taxes under the new or old regime. If it’s the new regime, 80C benefits won’t apply.
5. Redeeming Investments After 3 Years
Another common mistakes investors make when investing in ELSS funds. Most people think that they need to redeem their investment once the 3-year lock-in window is over. What they don’t understand is that:
ELSS funds do become redeemable after 3 years, but it doesn’t mean you have to withdraw your investment once the lock-in is over.
Redeeming without considering market conditions and future potential can possibly disrupt their potential wealth creation journey.
Solution: You may treat the lock-in period as the minimum investment window, rather than a fixed exit point. You may use the 3-year limit as a check point to reevaluate your investment in ELSS fund’s, overall performance, and your financial goals to make informed withdrawal decisions.
6. Failing to Consider Investment Risk
Many investors only consider the tax benefits of ELSS funds. They fail to understand that ELSS funds are equity-oriented mutual fund schemes, which means they typically carry very high risk than debt-oriented and hybrid funds. This leads to:
Investing in ELSS funds without considering your risk appetite.
Investing more than what your risk tolerance can handle.
Failing to understand how ELSS funds are subject to market volatility.
Having misaligned expectations about ELSS fund potential returns.
Solution: Instead of treating an ELSS fund as a tax-saving investment, look at it as an equity-oriented mutual fund with tax benefits. This way, you will be more likely to consider your risk appetite and invest within your risk tolerance limits.
7. Focusing Only on Past ELSS Fund Returns
Many investors simply invest in recommended ELSS funds or choose funds solely based on the past returns of ELSS funds. They fail to analyse and compare ELSS funds on the basis of:
Expense ratio
Portfolio composition
Investment strategy
Fund manager expertise
Solution: Look beyond the past returns of ELSS funds. Compare the performance of the fund with its benchmark and check if it aligns with your goals and risk appetite.
(Note : Past performance may or may not be sustained in the future.)
ELSS Mutual Funds vs. Traditional Tax Saving: Which Should You Choose?
Conclusion
If you’re considering investing in ELSS mutual funds for tax benefits, avoiding a few common mistakes can help you make better investment decisions. Things like failing to understand the lock-in clause, how the tax benefits of ELSS funds actually work, and even the risk associated with these funds can be a problem.
Understanding all these common mistakes can help you formulate a clear investment strategy for ELSS funds to both optimise tax benefits and long-term potential wealth creation.
Disclaimer:
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