What is Lock-in Period for ELSS? And Why It Does Not Matter?
Tax-saving schemes are excellent investments and help to reduce your liability. Equity-Linked Savings Scheme (ELSS) is the latest addition to the list of tax-saving products available to Indian investors. Under ELSS, a majority of the corpus is invested in equities or related securities. Investments made towards ELSS are eligible as deductions as per section 80C of the Income Tax Act, 1961. Additionally, along with the principal amount, the dividends as well as the maturity amount are also exempt from taxation.
ELSS investments come with the condition of a three-year lock-in period. In other words, ELSS units are non-redeemable for three years from the investment date. Many investors wonder about the significance of this lock-in period. Let us try to explore the advantages of long-term investment in ELSS.
Why do mutual funds have a lock-in period?
Here are four benefits of the lock-in period in mutual funds:
- Gives sustainable returns
- Gives higher returns
- Brings stability in your investment and helps in risk management
- Brings about investment discipline
Let us understand each of these in detail:
A long-term commitment allows fund managers to take a bottom-up approach i.e. select stocks purely depending on their prospects and not short-term market volatility. The focus then is to grow profits sustainably over three years or more.
Good investments need to be nurtured over a longer period so they may provide optimum returns. Historically, equity as an asset class has outperformed traditional tax-saving investments, especially in emerging markets. It is common for equity shares to drop significantly in value over a shorter period. Over a longer period, though, investors are able to ride out some of these highs and lows to generate better returns. Therefore, to take optimum advantage of ELSS, a longer investment horizon of five to ten years is advisable.
Stability and risk management
If you look at the relationship between volatility and time, you will find that investments held for longer periods demonstrate lower volatility than those held for shorter periods. A common mistake is to run at the first sign of trouble. You may often panic when you see a decline in the value of your investment. However, staying invested in ELSS on a long-term basis will pay off. The lock-in period for ELSS prevents this panic mentality from sabotaging returns by making it mandatory for investors to stay invested for at least three years.
You may buy ELSS online or offline with as less as INR 500. There is no cap on the maximum amount that may be invested. When you opt for a Systematic Investment Plan (SIP), you are able to invest smaller amounts at regular intervals developing investment discipline.
What is the lock-in period for one-time investment in ELSS?
Assume you invest a lump sum in one of these tax-saving investments on 1 April 2017. You are able to acquire 5,000 units for your principal amount. All these units are available for redemption on 1 April 2020 at the end of the three-year lock-in period.
What is the lock-in period for ELSS when invested through SIP?
Now assume that you buy ELSS online in five monthly installments on 1 April 2017, 1 May 2017, 1 June 2017, 1 July 2017, and 1 August 2017. Further assume you acquire 1,000, 900, 800, 700, and 600 units respectively. The first 1,000 units may be redeemed after 1 April 2020, the next 900 after 1 May 2020, and so on. All the units may be redeemed after 1 August 2020 once the three-year lock-in period on each SIP installment is over.
The lock-in period for ELSS funds is not a hindrance as you may believe. Instead, it is a safety mechanism to protect your returns. When your objective is to earn substantial returns over a longer period, the lock-in condition does not matter.
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