ELSS- Equity Linked Saving Schemes

What is an ELSS?

ELSS is Equity Linked Saving Scheme is a type of mutual fund that comes with a mandatory lock-in period of 3 years. As the name suggests, it is an equity fund that prominently invests in equities. ELSS mutual funds allocate 65% of its funds to equity investments and the rest 35% to other instruments. ELSS is the only type of mutual fund that is eligible for tax deductions under section 80C.

What are the Features of ELSS?

Here are the key features of ELSS mutual funds:

• They offer tax deductions of up to Rs 1,50,000 annually under Section 80C.
• ELSS funds have a lock-in period of three years and do not allow any premature withdrawals.
• You can invest any amount in ELSS, though fund houses set minimum investment requirements.
• ELSS funds can sometimes provide inflation-beating returns.
• Investing in ELSS provides both tax benefits and opportunities for wealth growth.
• ELSS fund portfolios mainly consist of equities, with some allocation to fixed-income securities.

What are the Tax Benefits of ELSS Mutual Funds?

ELSS is the only type of mutual fund that comes with certain tax benefits. Let’s see what tax benefits ELSS offers -

• As per the Income Tax Act, any investment made in ELSS is eligible for deduction under section 80C. A deduction of upto 1.5 lakh is available for investment in ELSS and save taxes upto Rs.46,800.
• These funds come with a minimum lock-in period of 3 years, which means you cannot redeem it before 3 years. Therefore, when you redeem your ELSS funds, you have to pay long-term capital gains tax @10%; however, if the gain is upto Rs.1 lakh, then there is no tax.

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A Brief Comparison of Various Popular Tax-saving Investment Instruments

ELSS vs Other 80C Investments - Why is ELSS the Best?

Even with taxed returns, ELSS outperforms other Section 80C investment options like Public Provident Funds (PPFs) and ULIPS, offering higher post-tax returns.

Higher Returns on Investment (ROI)

ELSS primarily invests in equity instruments, resulting in significantly higher returns over the long term compared to most tax-saving investment options. This not only saves taxes but also generates substantial profits. With historical performance indicating around 12% returns over ten years, ELSS stands out against PPFs, which offer approximately 8% returns.

Shorter Lock-in Period

ELSS boasts a shorter lock-in period of just three years, contrasting with PPFs, NSC, and EPF, all of which require a minimum five-year lock-in period.

Flexibility with ELSS

While ULIPs may yield similar returns to ELSS over time, they lack the flexibility offered by ELSS. With ELSS, investors can switch funds without committing to multi-year deals. In contrast, with ULIPs, investors are limited to funds offered within the ULIP.

Advantages of Combining ELSS and PPF

Combining ELSS with PPF offers significant benefits, combining the stability of PPF with the earning potential of ELSS. This diversifies portfolios with both debt and equity components, providing government-backed security alongside growth opportunities through equities.

Protection during Volatility

ELSS mutual funds serve as an entry point for investors in equity-linked investments, fostering discipline with a three-year lock-in period. These funds also shield against market volatility, benefiting from market highs while mitigating the impact of market lows.

What are the Factors to Consider Before Investing in ELSS?

Consider the following factors when choosing to invest in an ELSS mutual fund:

• Investment Horizon: If you have an investment horizon of more than five years, then you can consider investing in ELSS. The equity exposure in ELSS funds requires a longer timeframe to manage market volatility effectively.
• Returns: ELSS funds do not guarantee returns, as they depend on the performance of underlying securities. However, with an investment period exceeding five years, they often yield higher returns compared to other tax-saving options.
• Lock-in Period: ELSS mutual funds have a mandatory lock-in period of three years. You cannot redeem your investments until three years from the investment date have passed.

How to Invest in ELSS?

ELSS is available in two options:

• Growth Option: If you are looking to create a corpus for a long-term goal, then this is the most suitable option for you. ELSS does not provide any regular payouts, but keep on accumulating the funds in the scheme, which will be reflected in your NAV of the fund. Moreover, profits are re-invested to earn you more money.
• Dividend Payout Option: If you want a regular cash flow, you can avail this option. Under this, an investor receives a dividend whenever it is announced by the mutual fund. As a result, the dividend is tax-free in the hands of the investor.

Investment in ELSS can be made in two modes:

You can invest in ELSS either through lumpsum or SIP modes -

• Investing through a Systematic Investment Plan (SIP) is recommended for those who prefer lower risk. SIP allows you to invest in a fund consistently across market cycles, enabling you to purchase more units when markets are down and fewer units when markets are up. This averaging out of purchase prices over time can result in lower overall costs. When markets rise, this strategy can lead to higher capital gains upon redemption, a benefit not available with lump-sum investments.
• On the other hand, investing a lump sum is advisable only during bearish market trends, for investors willing to take higher risks and with a longer investment horizon. Lump-sum investments miss the opportunity to spread purchases across market cycles, typically requiring longer investment durations of 5-7 years to realize significant gains.

How to Select ELSS Tax Saving Funds?

One should carefully scrutinize various ELSS schemes before making investments. Gauging your risk appetite and the time horizon for which you can stay invested. Above all, it is essential to let you choose the fund that best suits your investment goals.

Best ELSS should be a scheme that gives you wealth in the longterm along with peace of mind. Therefore, you must conduct a thorough research of the fund before investing.

5 Things to Consider Before Investing in ELSS

• Past Performance: Funds that have performed consistently, even in times of market downturn, could be considered reliable. The performance must be checked on a time horizon of at least 5 years. In other words, good results are not yielded if the funds are selected on the basis of short-term performance.
• Reputation and size of the Fund Management Company: Funds with higher AUM (Asset under management) can be considered more reliable. Since it denotes that investors trust the particular fund more.
• Fund Manager: It is imperative to collect information about the person managing your hard-earned money. His investment idea and track record of performance of the funds managed in the past, mainly at the time of market downturn, is essential for you to know.
• Portfolio of the Fund: You should look for your scheme’s offer document to understand the type of equities your scheme would be investing in. The investment could be in a highly volatile market or relatively less volatile or stable, depending on your risk-taking ability.
• Expense Ratio: It is the fund’s operating expenses in relation to the AUM ratio. In general terms, it is the fee charged by the mutual fund for operating your scheme. In addition to that, your return gets lowered because of these expenses. Hence, selecting a fund that has got lower expense ratio than its peers would be beneficial.

Now that you know the benefits of investing in ELSS, don’t miss out on the tax savings and twin benefits that the scheme provides. Smart investment is the key to financial growth. And if you need more tax-saving tips and tricks, connect with our tax experts. File ITR Now with Experts