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The common trend to reinvest
ELSS funds stand for Equity Linked Savings Schemes mutual funds. They are mostly midcap equity funds that invest in the stock market. The difference with the other usual equity funds, however, is that the investor can claim tax deduction up to Rs. 1,50,000 in a year under Sec 80 C for investment in these funds. But these funds come with an initial lock-in period of 3 years. The investor cannot withdraw his investments before this period ends.
A general trend nowadays among investors is to invest in the ELSS funds for the initial period of 3 years. As soon as this lock-in period gets over, they withdraw the money and again reinvest it in the same fund to claim tax benefits for that year. This might seem to be a good strategy but ultimately it is harmful in the end. Here’s why:
Reinvesting hampers long term wealth creation
Any money, when invested for a year in an ELSS fund, gains some simple interest based on the NAV of the fund for that year. This interest is added to the original principal and the total sum is the new principal amount for the second year. Likewise, this keeps on happening for the third year and so forth. This is known as compounding. It is what helps the money to grow into a large corpus over the long term.
Now after 3 years lock-in period, if an investor withdraws all the money then it loses the ability to compound. When it is reinvested, it will be like a fresh investment which has to again go through the compounding process to grow.
Also read: ELSS or PPF: Which is a better tax saving investment option?
ELSS funds should be mapped with long term goals
All ELSS investments should be linked to financial goals. ELSS funds provide the dual benefits of tax saving and growing money by investing in equity. Hence if someone withdraws the money after 3 years and reinvests it, he may save taxes for that year but he is not allowing his money to grow over the long term.
Some situations where one can reinvest
Although it is advisable not to reinvest ELSS investments after the lock-in period is over, still, this strategy can be followed in certain situations. Suppose if a person does not have money to invest in a particular year but still he wants to save taxes for that year then he can follow this strategy.
Persons who have already retired from service can also follow it. Their main investments can be done in debt mutual funds so that the principal amount is safe. And they can keep reinvesting the money in ELSS funds every 3 years to take advantage of the tax benefits.