How does ELSS lock-in period encourage a disciplined investing approach?

Investing in equities requires a disciplined approach. One of the most significant challenges that investors face is the tendency to withdraw their investments in panic during market volatility. This behaviour can lead to potential losses and hamper long-term wealth creation. To address this issue, Equity Linked Savings Schemes (ELSS) funds were introduced with a mandatory lock-in period, encouraging investors to stay invested in the scheme regardless of market conditions.

In this article, we will discuss how the lock-in period in ELSS funds promotes a disciplined investing approach.

• Table of contents

1. What are ELSS funds
2. Understand lock-in period in ELSS funds
3. How the lock-in period of 3 years works?
4. Method of Investing and Lock-in Period
5. Benefits of the lock-in period in ELSS fund
6. How ELSS fund is promoting disciplined investing approach?
7. What to do when the ELSS 3-year lock-in period ends?
8. What happens to ELSS after 3 years?

What are ELSS funds

Equity-Linked Savings Schemes (ELSS) are mutual funds that invest at least 80% of their assets in equities and related instruments. ELSS funds also offer tax benefits under Section 80C of the old regime of the Income Tax Act, 1961, with a deduction limit of Rs. 1.5 lakh per year. These funds have a mandatory three-year lock-in period, encouraging a long investment horizon. They also offer significant capital appreciation potential in the long run.

Understand lock-in period in ELSS funds

ELSS (Equity Linked Savings Scheme) funds are mutual funds that invest in equities and offer potential tax benefits to investors. They are designed to promote savings and investment among investors, while also providing tax deductions under Section 80C of the Income Tax Act, of 1961.

ELSS funds are unique in that they have a lock-in period of three years, which means that investors cannot withdraw their investments before the completion of three years from the date of investment. The compulsory lock-in period is intended to encourage investors to stay invested for the long term and to discourage short-term trading.

Additionally, like other mutual funds, even ELSS funds are managed by professional fund managers who invest the pooled money in a diversified portfolio of equity stocks. The fund managers aim to generate capital appreciation by investing in a mix of equity and equity-related instruments, while also ensuring that the investments are aligned with the objectives and risk profile of the scheme.

How does the lock-in period of 3 years works?

The three-year lock-in period for ELSS indicates that investments are ‘locked in’ – that is, they cannot be withdrawn before three years from the investment date. Once the 3-year lock-in period ends, you have the flexibility to redeem your investment, continue holding it, or switch to another fund (if the switch facility is offered by the asset management company).

Method of investing and lock-in period

The functioning of the lock-in period is straightforward for lumpsum investments but differs slightly for SIPs. Here’s how it works:

Lumpsum investments: The lock-in starts from the date of the one-time investment.

SIP investments: Each installment has a separate 3-year lock-in starting from its respective date.

Example:

If you invest Rs. 10,000 in an ELSS fund on January 1st, 2024, you cannot withdraw this amount before January 1st, 2027.

If you invest in the same ELSS fund via SIP with monthly installments of Rs. 5,000, each installment will have its own 3-year lock-in period starting from the date of that specific installment.

Benefits of the lock-in period in ELSS fund

There are several features of ELSS funds over the lock-in period, including:

• Duration: The lock-in period for ELSS investments is 3 years. This means that once you invest in an ELSS scheme, you cannot redeem or withdraw your investment for a minimum of 3 years from the date of investment.
• Commitment: Investors need to commit to keeping their funds invested for the entire lock-in period. Partial withdrawals or premature redemption is not allowed during this time.
• Tax benefits:ELSS investments offer tax benefits under Section 80C of the Income Tax Act, 1961. Investors can claim deductions of up to Rs. 1.5 lakh per financial year on the amount invested in ELSS schemes. Moreover, capital gains from ELSS schemes are classified as long-term capital gains. As per the latest Union Budget (2024), long-term capital gains of up to Rs. 1.25 lakh in a financial year are tax-exempt. Thereon, they are taxed at 12.5%.
• Long-term investment:ELSS is designed as a long-term investment vehicle. The lock-in period encourages investors to stay invested for a longer duration, which may help in generating potentially higher returns over time. This is because of the power of compounding. When returns are reinvested, they can go on to earn further returns. Over time, this can have a multiplier effect. The longer the investment horizon, the more significant the potential impact of compounding. A compound interest calculator can help you visualise this. You can input different investment horizons to see the resultant change in return potential to understand the benefits of long-term investing. A lumpsum mutual fund calculator can similarly help investors considering a one-time lumpsum investment.
• Flexibility: After the completion of the lock-in period, investors have the flexibility to either redeem their investment or stay invested in the ELSS scheme based on their financial objectives.

How do ELSS funds promote a disciplined investing approach?

How does the lock-in period in ELSS funds promote discipline? Lock-in periods in ELSS funds promote a discipline in the following ways:

• Encourages long-term investing: The lock-in period encourages investors to adopt a long-term investing approach, which is essential for potential wealth creation. By restricting withdrawals, investors are forced to stay invested for the long haul, which can help them ride out short-term market volatility and potentially benefit from the power of compounding.
• Reduces emotional investing: The lock-in period helps investors avoid making emotional decisions based on short-term market fluctuations. Investors are less likely to panic and withdraw their investments during market downturns, which can help them avoid potentially significant losses.
• Helps investors avoid market timing: The lock-in period helps investors avoid trying to time the market, which can be a risky strategy. By staying invested for the long term, investors can ride out interim volatility without trying to predict market movements.
• Promotes discipline: The lock-in period promotes discipline among investors by restricting their ability to make frequent changes to their portfolio. This discipline helps investors stay focused on their long-term goals and avoid making impulsive decisions based on short-term market trends.

What to do when the ELSS 3-year lock-in period ends?

Once the 3-year lock-in period for your ELSS investment ends, you have the following options:

1. Redeem your investment:

Full redemption: Withdraw all units in the fund.

Partial redemption: Withdraw a portion while keeping the rest invested.

Systematic Withdrawal Plan (SWP): Regularly withdraw fixed amounts (e.g., monthly, quarterly).

It is important to consider that upon redemption, capital gains will be subject to tax. A LTCG of 12.5% will be applicable on capital gains exceeding Rs. 1.25 lakh in a financial year.

2. Continue investing:

Hold and grow: Retain your investment to benefit from potential market growth.

What happens to the ELSS investment after 3 years?

After your lock-in period ends, your money continues to stay invested and access growth opportunities. You can choose to withdraw the money if you with to or stay invested if you are yet to reach your goal date.

Conclusion

The lock-in period in ELSS funds is a critical feature that promotes a disciplined investing approach among investors. By restricting withdrawals for a specified period, ELSS funds encourage investors to adopt a long-term investing approach, reduce emotional investing, and foster discipline. By investing in ELSS funds with a lock-in period, investors can develop a habit of disciplined investing and avoid market timing, which can potentially help them to achieve their long-term financial goals.

FAQs

Can I withdraw my investments before the lock-in period is over?

No, investors cannot withdraw their investments before the three-year lock-in period is over.

Do ELSS funds offer any tax benefits?

Yes, ELSS funds offer tax benefits to investors under Section 80C of the Income Tax Act, 1961. Investors can deduct up to Rs 1.5 lakh per year from their taxable income by investing in ELSS funds.

Can I invest in ELSS funds through SIP?

Yes, many ELSS funds offer a Systematic Investment Plan (SIP) option, which is a convenient and affordable way of investing in mutual funds. You can also use an SIP goal calculator to evaluate your potential returns and effectively plan your investments.

What should an investor do when the lock-in period ends?

After the 3-year lock-in period, ELSS investors can redeem their investments fully or partially. You can also continue holding the investment to benefit from potential growth.

What happens to ELSS funds after lock-in ?

After your investment completes the three-year lock in period, it becomes liquid and can be redeemed at any time. You can choose to stay invested or redeem all or a part of your funds, depending upon your tenure, goals and overall investment strategy.

Is ELSS tax-free after the three-year lock-in?

The tax benefits on ELSS only apply to the invested amount and only investments of up to Rs. 1.5 lakh across eligible schemes under Section 80C of the Income Tax Act, 1961 can be reduced from your taxable income in every financial year. All returns are subject to long-term capital gains tax at redemption.

However, you can continue investing up to Rs. 1.5 lakh each financial year ELSS if you seek tax benefits. Each investment is treated as a new instalment and has a three-year lock in period.

How do you break a three-year lock in of a mutual fund?

The 3-year lock-in period for ELSS is a regulatory requirement and cannot be broken.

What happens if you sell ELSS before the lock-in is over?

Selling ELSS units before the 3-year lock-in period is not possible. Consult a financial advisor and explore other options if you are in urgent need of funds during this period.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.