Difference Between ELSS vs SIP in Mutual Funds

If you are an investor searching for good investment options with lesser risk and stable returns, consider an equity-linked savings scheme (ELSS) and a systematic investment plan (SIP).

While ELSS offers tax savings, it comes with a mandatory lock-in period. SIP comes with regular investment, thus helping new investors. This article will give you an insight into the difference between ELSS and SIP, enabling you to choose the best option for your investments.

Equity-linked Savings Schemes (ELSS) are equity-based schemes that invest a significant portion of their assets in equity or equity-related instruments. They have a lock-in period of three years and are also called tax-saving schemes.

They offer tax exemption of up to ₹1.5 lakhs from the annual taxable income under section 80C of the IT Act. This feature of tax saving and the possibility of higher and stable returns enable them to be a lucrative investment instrument among investors.

How Does ELSS Work?

Knowing about ELSS's working principle helps you make an investment plan according to your financial goal. Follow the points given below to learn about the workings of ELSS:

• Equity-Based Investments: ELSS are equity-oriented schemes with a diverse portfolio. They primarily invest in stocks of publicly traded companies with large, mid-, and small-cap firms and industries.
• Wealth Optimisation: This fund's objective is to maximise long-term wealth appreciation. The fund manager carefully selects stocks through extensive market analysis to achieve higher returns by reducing the risks.
• Investment Limit and Savings: The ELSS scheme has no cap on the investment amount. However, only up to ₹1.5 lakhs are eligible for tax deductions, thus potentially saving up to ₹46,800 annually.

A Systematic Investment Plan (SIP) is an instrument through which an investor invests a fixed amount of money into a mutual fund scheme at periodic intervals. It prevents the shock of sudden market fluctuations due to periodic investment.

Further, fluctuation is prevented by averaging the purchase price of stocks. Additionally, when the prices of mutual funds are low, SIP enables us to accumulate higher units of stocks. This helps us fetch higher returns in the long run.

How Does SIP Work?

The working principle of SIP enables us to analyse our investment's long-term returns and fluctuations. Here's a breakdown of how an SIP works:

• Automatic Debit and Investment: Once the SIP plan is subscribed to, a fixed amount is automatically debited from your bank account. It happens at a predetermined interval, and the deducted amount is deposited into the mutual fund selected.
• Allocation and Addition of Units: The mutual fund allocated is based on the fund's Net Asset Value (NAV) on the investment date. Every installment adds additional units to the account at the prevailing market rate.
• Compounding Effect: As the investment grows with each instalment, the reinvested amount becomes more considerable. This increases NAV as the investors hold more units, resulting in higher returns over time.
• Flexibility of Returns: Investors can withdraw the return in the form and way they want. They can receive their returns at the end of the SIP's tenure or opt for periodic payouts.

1. Tax Implications of ELSS

To invest in the ELSS scheme, it is necessary to keep an eye on the taxation rules of ELSS. This will enable us to fetch higher returns for our investments. To make you aware, the taxation rules of ELSS are discussed below:

• Lock-In Period: The ELSS fund has a lock-in period of three years. Therefore, you can only realize the long-term capital gains (LTCG). LTCG is tax-free up to ₹1 lakh per year. Any earnings beyond ₹1 lakh are subject to 1a 0% LTCG tax.
• Section 80C of the IT Act: This section enables tax deduction benefits on the invested principal in the scheme. Since it is a cumulative deduction, it benefits the investors by availing a tax deduction of up to ₹1.5 lakh.
• Redemption: A three-year mandatory lock-in period provides investors with LTCG when redeeming the units. Gains up to ₹1 lakh in one financial year are not taxable. However, a 10% tax is levied if the gain exceeds the limit.

2. Tax Implications of SIP

Knowing the basis of SIP and ELSS can help you make an informed decision regarding your investment goals. SIP makes mutual funds readily accessible to investors by the discipline of regular investments. Alternatively, the ELSS fund is also a tax savior with potential capital growth during the lock-in period.

However, choose the plan that aligns with your financial goals, risk tolerance, and investment potential to reap good returns.

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