Tax planning in India traditionally has been associated with an annual exercise where the employer informs employees about a particular date for the submission of tax investment proofs. While ideally, tax planning works best when aligned with an investor’s goals and long-term objectives, very often last-minute tax saving attempts lead to investing in avenues that offer less than optimum wealth appreciation. However, there is one investment option that offers the dual benefits of wealth creation and tax saving to investors – ELSS tax saving funds.
ELSS (Equity Linked Savings Scheme) is similar to a diversified equity mutual fund and comes with the additional benefit of tax savings. Among all Section 80C investment options, ELSS offers the shortest lock-in period of three years. Moreover, being an equity fund, it has the potential to reap results in the long run as well.
It’s important to note that while there is no limit on the maximum amount that can be invested in ELSS, tax exemption is available only for Rs 1.5 lakh in a financial year. The amount hence can be invested in Equity Linked Saving Schemes in two ways – in one go or ‘lumpsum’ or through ‘SIP’.
Let us understand the two in detail and also look at which one is better:
Systematic Investment Plan is a way or ‘method’ of investing in ELSS or a mutual fund. The investor after choosing the scheme to invest in, fixes the amount and frequency of investment. For ease of understanding, it can be considered similar to a bank Recurring Deposit or RD, the difference being that the fixed amount in case of SIP buys units at the applicable Net Asset Value or NAV.
Let us look at some of the benefits of SIP investing:
1 Disciplined Investing
Systematic Investment Plan ensures continuity and inculcates a habit of regular contribution, as per the chosen frequency. The flexibility enables investors to choose an amount as per their monthly expenses and surplus available. Once the investors have seen the results, the effort to maintain the discipline sets in. The regular flow also ensures that the corpus continues to increase in size and lets the power of compounding work its magic.
Averaging or Rupee Cost Averaging is a simple concept which is a unique feature of Systematic Investment Plan. Since markets do not move in a straight line, SIP investment ensures that scheme units are being purchased regularly irrespective of the market levels. So, more units are bought when the market is low and vice versa. This eventually results in cost averaging and also helps in smooth sailing through volatility.
3 Aligned with specific goals
A major benefit of investing in ELSS through SIP is that the investments and frequency can be aligned with both long term as well as short term goals of the investor. ELSS is not merely a Section 80C tax savings product, but an investment vehicle which can be utilised for achieving specific personal financial goals.
Lump Sum Investing
Lump Sum essentially means ‘one time investment’ or investing the entire amount in one go. Let’s see some of the advantages of this investment mode.
Advantages of lump sum investing:
For individuals with sufficient savings or balances and with knowledge of markets and investing, a lump sum investment can prove to be beneficial. This is also applicable for people engaged in business who might not have regular cash flows but can accommodate lump sum investments at the time of tax planning.
2 Year End Tax planning
During the annual document submission exercise, when there is no time at hand, lump sum is the option that the investor has to go with. Although this form of investment is simple, an ideal approach would be investing from the start of the financial year itself.
SIP or Lumpsum?
Now which mode to select for your ELSS investments is a factor of certain key attributes like
1 Lock in period v / s liquidity
ELSS investments come with a lock in period of three years. SIP amounts would have a spread out maturity period as per the frequency of investment plan whereas lump sum amounts would be available for redemption immediately after completion of three years. For example, if an investor deposits their entire capital in an investment plan of 3 years on 1st September 2017, all the units will mature on 1st September 2020 and will be available for withdrawal any time after that.
If invested via SIP, the scenario will be different. Here, an investor deposits funds every month, starting from 1st September 2017, 1st October 2017, 1st November 2017, and so on. After 3 years, the units bought on 1st September 2017 will mature on 1st September 2020, 1st October 2017 units will mature on 1st October 2020, 1st November 2017 units will mature on 1st November 2020, and so on. The choice of investment would depend on an investor’s liquidity objectives – in case someone is looking for liquidity of these investments at regular intervals after completion of three years, then the SIP route is preferred.
2 Fund requirement
This would differ from person to person. Some investors invest strictly with the time frame in mind and might need the entire amount after completion of three years. Others, on the other hand, might choose to stay with the investments for a longer time period, depending upon the scheme’s performance and their need.
3 Risk tolerance
An individual’s risk assessment with respect to the chosen investment would prove beneficial in answering the ‘how’ question. Markets work in cycles and investors react to market volatility and ‘cycles’ differently. For some, risk mitigation comes with SIP investing, while for other, educated and aware investors, lump sum investing might prove to be a better option.
In case of redemptions, a bull market is obviously better for investors. However, while accumulating units, continuous bull markets would be disadvantageous for SIP investors, as units bought will be fewer.
A bear market will work for both SIP and lump sum investors during the accumulation stage, as more units will be bought. However, this means that investors are indulging in timing the market, which by all means, is a futile exercise.
SIP investing has proved to be successful on the premise that it is not possible and prudent to time the markets.
Last-minute tax rush often leads people into making lump sum investments into new funds every year, which essentially leads to fund overlap.
Thus, it is not about ‘which one of the two’ but more about suitability of one against the other. The decision should be well planned and based on the investor’s risk tolerance and funds availability – along with the goals and time-frame.