ELSS vs SIP: Key Differences You Need to Know

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Introduction

Investment in a mutual fund is often preferred compared to a direct investment in shares, especially in the case of investors who do not have the time to study the market in its entirety. One common form of mutual funds is ELSS funds. Meanwhile, investments in mutual funds can either be a lump sum investment or a recurring investment. Both kinds have their advantages and drawbacks.

Additional ReadELSS Calculator – A Step-by-Step Guide to Assess Your Investments

While lump sum investments provide higher rates of return, the amount tends to be higher. The recurring investment type is easier on the wallet but offers lower rates compared to the former. In this article, let’s explore how these two types of investments differ from each other and how to choose one type.

What is ELSS?

Equity-Linked Savings Schemes, or ELSS, are mutual funds that are focused on equity investments. ELSS mutual funds invest their capital in equity and equity-related instruments and can be compared to diversified equity funds. These funds come with tax benefits for those who invest in them. ELSS funds have a tax-saving feature provisioned under Section 80C of the Income Tax Act, 1961. Investing in an ELSS fund allows the investor to claim a deduction of up to Rs. 1.5 lakh per financial year.

Although ELSS are tax-saving funds in a way, they differ in their investment pattern and their rate of return. ELSS mutual funds primarily invest in equity instruments in the market, and the exposure allows the investors a higher return rate. Traditional tax-saving instruments like PPF and NSC offer relatively lower rates to investors.

The mandatory lock-in period for ELSS is three years, which is quite less than traditional tax-saving funds, making ELSS preferable in this cadre. After three years, the investors can partly or fully redeem their investment.

ELSS mutual funds are managed by professionals who conduct extensive research and analysis. However, the funds don’t offer guaranteed returns, since they invest in shares that are subject to market risk.

Additional Read: Income Tax Implications on Demat Account

What is SIP?

Many mutual fund investments can either be lump sum or recurring. The recurring deposits in this context are called Systematic Investment Plans, or SIPs. In such cases, the investor deposits his investment periodically.

SIPs can be characterized by certain features which are listed below. ‘

Affordability: SIPs are designed with affordability in mind. Investors who can’t set aside a lump sum can opt for SIPs and regularly invest a small amount. This affordability introduces the motivation to invest in low income individuals who may not have thought about investment otherwise. SIPs offer cost-effective limits on minimum amount of investment. Overall SIP investments encourage investors to put their money into mutual funds by making these investments affordable for them.

Disciplined Investment: Investing in SIPs is a regular and disciplined process. This encourages investors to regulate their periodical savings. The investor would develop a consistent investment routine thanks to the recurring deposit pattern, and this consistency might inculcate an investment habit in the individual. Moreover, SIPs allow investors to increase or decrease their recurring investment amount, and this would serve as a motivation to increase their savings as well.

Rupee Cost Averaging: Unlike lump sum investments, SIPs happen over a period of time. This means that they would touch upon multiple price points of the fund’s units. Some units would be priced higher and some would be priced lower, and spread across time, the cost of units are expected to average out. The pressure of timing the market right is absent in this format of investment. Compared to a one-time purchase of units, SIPs come with a lower risk for loss from fluctuations in the NAV (net asset value) of the fund.

Risk Mitigation: The fact that SIPs are spread over time not only helps the investors average out of their cost of investing in the fund but also helps them avoid losing all their money to a highly volatile market. Supposing a fund loses money due to a major market fluctuation, and the fund’s NAV comes down significantly, the SIP investor earns an edge by getting a lower price for further units of the fund. They also get to decide if they wish to stop investing in the fund any further. The risk factor comes down significantly in SIP investments.

Additional Read: Maximizing Your Returns with the SIP Return Calculator

Key Differences - ELSS Vs SIP

ELSS - Equity-Linked Savings Schemes

SIP - Systematic Investment Plan

This is one kind of tax-saving mutual fund scheme.

This is an investment method that requires regular investments in a mutual fund.

ELSS funds come with a 3-year mandatory lock-in period.

SIPs typically have no lock-in period. They are highly liquid.

ELSS is a lump sum investment and is made as a one-time payment.

SIP is a recurring investment and is made in periodical payments such as per month or per quarter.

ELSS funds are eligible for tax deduction under section 80-C of the Income Tax Act.

SIPs aren’t directly eligible for tax deductions and the returns would be fully taxable.

ELSS investments offer a limited amount of flexibility.

SIPs offer a generous amount of flexibility.

ELSS investments are suitable for those investors who seek to reduce tax liability by investing their income.

SIPs are suitable for those investors who seek to invest in a regular and disciplined investment routine, and aim at increasing their wealth over time.

ELSS investments expose investors to the market and subject them to risks and potential volatility associated with the market.

SIPs enable rupee cost averaging, because the investments are spread over time. This reduces the harsh impact of the market and its fluctuations on the investors.

ELSS or SIP - Which is Better?

From their differences it can be seen that ELSS and SIP are not directly comparable. They belong to different categories altogether. However, if we have to compare, we can look at certain key aspects. ELSS offers tax savings which SIPs don’t offer.

SIPs on the other hand offer so much more to compensate. They are more liquid, and the risk is limited. SIPs are also more affordable and they do not have a lock-in period. When we consider the rupee-cost averaging benefit that SIPs carry, in addition to their flexibility, they clearly have an edge over ELSS. But then which is truly better depends on the individual who is making a choice based on their expectations.

Conclusion

If one has to choose either ELSS or SIP for investing the decision is probably best made on the basis of their objective. If one wishes to invest in a fund that will help them save on taxes then they should go for ELSS. If they wish to invest in a fund which allows periodic recurring deposits, to increase wealth with small investments spread over time, then one should go for SIP. As with most cases, choices depend on the individual and their needs and the compatibility they find with the option they pick. 

Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.

This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.

For All Disclaimers Click Here: https://bit.ly/3Tcsfuc

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