The word ‘lock-in’ sounds negative to many investors. The idea of not being able to access your money feels restrictive. However, when it comes to ELSS (Equity Linked Savings Scheme) funds, this lock-in is not a limitation—it’s actually a powerful wealth-building feature.
ELSS funds combine tax-saving benefits with equity market exposure, offering the shortest lock-in period among all Section 80C options. More importantly, this 3-year lock-in plays a crucial role in improving investor returns. This enforces discipline and reduces emotional decisions, and creates the ideal environment for long-term wealth creation.
What is ELSS and its 3-year lock-in?
ELSS funds are diversified equity mutual funds which can get tax deductions under Section 80C of the Income Tax Act. Investors can claim up to ₹1.5 lakh in deductions annually. These funds invest primarily in equities, which makes them suitable for long-term growth.
ELSS have a lock-in period of just three years. Unlike other tax-saving instruments, such as Public Provident Fund (PPF), which has a 15-year lock-in, or tax-saving fixed deposits with a 5-year lock-in, ELSS offers flexibility along with growth potential.
Each investment in ELSS is locked in for 3 years from the date of investment, which includes SIP instalments. It seems restrictive, but it enhances the returns in multiple ways.
Forced discipline: eliminates emotional investing
Many investors and traders get emotional during periods of market fluctuations. They experience fear during market crashes and greed during bull runs, which leads to panic selling or premature profit booking. As ELSS has a lock-in period, investors won’t be able to do anything. They are naturally protected from impulsive decisions as investors cannot withdraw their money during this time.
Power of compounding
Investing is about compounding your returns, but compounding needs time. The ELSS lock-in ensures that your investment remains untouched for at least three years. This allows compounding to work effectively.
Even a short interruption in compounding can reduce overall returns. By preventing early withdrawals, ELSS funds ensure that your money continues to grow uninterrupted. Investors aiming to further enhance long-term compounding can also consider diversifying into options like the Nifty orNifty Next 50 index funds, which provide exposure to high-growth potential companies.
Dual advantage
The ELSS offers the dual advantage of growth potential and tax savings. As per India’s income tax rules, you can claim tax benefits for ELSS funds under Section 80C. Also, as the ELSS has a lock-in period of 3 years, it comes under long-term capital gains (LTCG) taxation. In equities, LTCG up to ₹1.25 lakh per year is tax-free, and gains beyond that are taxed at a relatively low rate of 12.50%. This makes ELSS more tax-efficient compared to many fixed-income instruments.
Rupee cost averaging benefit with SIP
Many investors choose to invest in ELSS funds through Systematic Investment Plans (SIPs). Each SIP instalment is locked in for three years, creating a staggered investment structure.
Due to this approach, you can buy more units when prices are low and fewer when prices are high. Over time, this reduces the average cost of investment. The lock-in ensures that these accumulated units are not withdrawn prematurely.
Who benefits the most from ELSS lock-in?
The ELSS lock-in is especially beneficial for salaried individuals who are looking to save tax under Section 80C, first-time investors entering equity markets, and long-term investors.
However, it may not be suitable for those who need liquidity in the short term or prefer guaranteed returns.
Conclusion
Traders and investors often misunderstand the lock-in period of ELSS, but actually, it works in their favour. Lock-in period enforces discipline, prevents emotional trading and allows compounding to work without interruption. ELSS funds also offer tax benefits of up to ₹1.5 lakh, which can be claimed under Section 80C. Considering all these factors, 3-years of lock-in period actually helps you boost your returns.
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Image published by March 16th, 2020
