1) What are the tax benefits?
Up to Rs 1 lakh invested in ELSS funds in a year is eligible for deduction under Section 80C. However, unlike the life insurance policies, you cannot invest on behalf of a minor and avail of tax deduction. No tax is levied when you redeem your investment after the lock-in period.
Since ELSS funds have more than 65% of their corpus invested in stocks, they enjoy the exemption from tax on long-term capital gains as is the case with any other equity fund. The dividend income is also tax-free.
2) Will you get assured returns?
Since these are essentially diversified mutual funds, there is no guarantee on returns. The ELSS category has given an average return of 2.95% in the past five years. The best performing fund increased an investment of Rs 10,000 to Rs 16,519 during this period, but the worst performing scheme reduced it to Rs 5,991.
In the past three years, the average return has been 6.82%, while the best performing fund has given 13.5%. So, apart from the performance of the broader market, your returns are dependent on the fund manager's ability to pick the right stocks. This also means you must select the fund after proper research. Instead of picking a fund with high, but volatile, returns, choose one with a stable performance record.
3)What's the lock-in period?
The lock-in period is only three years, the shortest among all tax-saving options under Section 80C. You cannot redeem or switch to another option during this period. In the case of SIPs, each instalment is treated as a separate investment and will have a three-year lock-in period. So, if you started investing in an ELSS fund in April 2010, you can redeem the units bought in the first instalment only in April this year.
Those bought in May 2010 will be open for redemption only in May. The lock-in stipulation does not mean that the investor must compulsorily redeem the funds after three years. Unlike Ulips and pension plans, there is no maturity date of an ELSS fund. If you want, you can remain invested for a longer period.
4) Dividend, growth or reinvestment?
The dividend is only a profit-booking exercise since a fund's NAV reduces by the amount the investor receives as dividend. In the growth option, the amount remains invested for the entire tenure.
The dividend option provides a periodic income to the investor, though there is no obligation on the part of the mutual fund to declare a dividend or maintain its payout ratio year after year. The growth option has the potential to generate higher returns. Your choice should depend on your needs and risk appetite. Avoid the dividend reinvestment option because you will find it difficult to exit the fund completely. There will always be some units that have not completed the lock-in period.
5) How should you invest?
Unlike regular equity schemes, the ELSS funds have a lower investment threshold of Rs 500. You can invest a large amount at one go, but the best way to invest in equity-oriented instruments is through regular monthly driblets called SIPs.
For instance, if you have Rs 30,000 to invest in ELSS funds this year, split them into three instalments between now and 31 March. This will curtail the risk significantly by averaging out your cost of purchase. To start an SIP, submit post-dated cheques or give an ECS mandate to your bank. The money will be automatically transferred to your mutual fund every month.
Source : ET