ELSS Mutual Funds

One of the most popular tax-saving investment instruments for many Indian investors, ELSS funds can help save you tax, and grow your wealth. They offer more flexibility compared to the other tax-saving investment options. In this article, we will be learning about what ELSS funds are, how they work, the benefits of investing in these funds, and the factors you should consider before investing in them.

In November 2022, tax tech startup EZTax released Income Tax Filing, Compliance insights, and data analytics for the FY 2021-22 tax season. It showed that 71% of taxpayers employ no-to-low tax planning and savings strategies. 71% - That’s definitely a huge number. Having no tax planning or saving strategies is a true recipe for a financial disaster. So, in this article, we are going to tell you how investing in ELSS mutual funds can help save you a lot of money in taxes.

Equity Linked Savings Scheme (ELSS) is an equity mutual funds that invests a majority of its corpus into equity or equity-related instruments. ELSS funds are also called tax-saving mutual funds since they offer tax exemption of up to ₹1,50,000 from your annual taxable income under Section 80C of the Income Tax Act.

They are an excellent tax-saving investment option for everyone, especially newbie investors. Apart from ELSS, Section 80C also offers tax deduction benefits to investments made in other instruments like Public Provident Fund, National Savings Certificate, etc.

One of the main reasons why ELSS is loved by many is because they have the lowest lock-in period of three years when compared to other tax-saving instruments. A Public Provident Fund (PPF) has a 15-year lock-in period, and a tax-saving Fixed Deposit (FD) has a five-year lock-in period while the National Pension Scheme (NPS) has a lock-in period until retirement. Once the lock-in period ends, you can redeem or switch the units.

Also, among the other tax-saving avenues, ELSS has the highest potential for wealth creation in the long term. ELSS provides options to invest across both growth and dividend options. Investors should assess the fund's track record and choose one that suits their risk tolerance and helps them achieve their financial goals.

As mentioned above, an ELSS mutual fund invests a majority of its corpus in equity-linked instruments such as stocks. These stocks could be from several sectors and of different market capitalizations. The remaining corpus that is not invested in equities is invested in other fixed-income or money-market securities.

If the market value of the stocks in which the fund has invested rises, the investors will receive positive returns. On the other hand, if the value of assets declines, the investors will face loss.

These are the reasons why you should invest in ELSS mutual funds.

There are two investment modes through which an investor can invest in mutual fund schemes. They are

Lumpsum - You choose lump sum if you wish to invest one time in a mutual fund scheme. Usually, people choose this method when they receive a bonus, so they can put the money in a scheme as a one-time investment.

If you wish to know how much and how long you need to invest to achieve your goals, please check the Lumpsum Calculator, created by Koshex.

Systematic Investment Plan (SIP) - You choose SIP when you want to invest a fixed amount in a scheme at regular intervals. You can choose to invest ₹5000 every month or ₹10,000 every quarter. When the due date comes, your amount will be deducted automatically from your bank account and it will be used to purchase units of the mutual fund scheme.

If you wish to know how much you need to invest every month via SIP to achieve your goals, please check the SIP Calculator, created by Koshex.

ELSS funds are a perfect investment option for salaried individuals. When you earn a monthly salary, your company may deduct a certain amount towards Employee Provident Fund (EPF), which is a fixed-income product. Since EPF carries low risk, you can diversify your portfolio with ELSS. Since ELSS has the lowest lock-in period, they are easier for salaried employees in case they need to withdraw their investments after a few years.

ELSS funds are also a perfect option for newbie investors, who haven't invested a lot of money in equity-related instruments. Equity investing requires patience and discipline of staying invested for a long period of time. Newbie investors tend to withdraw their equity investment at the first sign of trouble. The lock-in period makes sure that you don't withdraw your equity investments when the market declines. Newbie investors can invest in ELSS via SIP, as it will help in rupee cost averaging. You can accumulate more units via SIP when the market falls.

Since ELSS funds invest more than 80% of their funds in equity and equity-related instruments, they are not a suitable investment option for those investors, who do not want to take any risks and want to invest only in safe instruments. Older individuals should consider other investment instruments, which carry lower or no capital risk. They can go for LIC policies, ULIP, and so on.

The first one is the most obvious benefit of investing in ELSS funds and that is, it helps you to save taxes. Equity-Linked Savings Schemes are the only equity funds eligible for tax deductions for investors. Under Section 80C of the Income Tax Act, you can avail of a tax deduction of up to ₹1.5 lakhs in a financial year.

ELSS funds come with a lock-in period of just three years. This is much lesser than the other tax-saving options under 80C, including Public Provident Fund, National Savings Certificate, Tax-Saving Fixed Deposits, etc.

With ELSS, investors can start their tax-saving journey for as low as ₹100 via the SIP mode.

Since ELSS funds have a link to the equity markets, they offer payouts that are higher than traditional tax-saving instruments. Statistics show that ELSS generates around 12% returns over 10 years on average. This is a huge jump over schemes like PPF, which offer around 7%.

You can invest any amount in ELSS funds, as there is no upper limit. Meanwhile, the minimum investable amount will differ across fund houses.

Your investment in ELSS funds can be grown by not redeeming them after the stipulated lock-in time of three years. As these funds invest in equities, they can create considerable wealth over a long period of time.

ELSS mutual funds invest a major portion of their funds in equity and equity-linked instruments and other securities, thus diversifying their portfolio. This diversification helps prevent big losses during highly volatile market conditions.

ELSS mutual funds are the only tax-saving instrument with the potential to offer inflation-beating returns.

Assessing the past performance of a fund helps to determine how it has performed. This will help you make an informed investment decision. The one thing you should note here is that past performance is not an indicator of how a fund will perform in the future.

The expense ratio is the amount of investment that goes into managing the funds. An investor should carefully consider the expense ratio as it can have a direct impact on the returns generated by the fund. If the expense ratio is low, the returns would be high, and vice versa.

ELSS funds do not offer guaranteed returns as they are dependent completely on the performance of the underlying securities. On the other hand, it is wise to have an investment horizon of over 5 years in order to earn higher returns.

Since a majority of ELSS funds' corpus is invested in equity or equity-linked instruments, it is important to understand that ELSS funds carry high risks. They are suitable for investors with a high-risk tolerance and if you are someone who would wish to invest in low-risk tax-saving investment instruments, you can consider PPF, NSC, tax-saving FDs, and so on.

Investors should consider the size of the fund, which is considered a good indicator when choosing a fund. Please note that this criterion should not be applied to newly launched ELSS funds. Investors should also take a hard look at the long-term performance of the fund and choose funds that have delivered consistent performance.

As mentioned above, ELSS funds come with a three-year lock-in period, meaning that you cannot withdraw your investments from them before the end of three years. If you require your funds in the immediate future, you can consider investing in liquid mutual funds or other debt mutual funds, which are suitable for short-term goals and have high liquidity.

ELSS mutual funds are subject to capital gain and dividend tax.

Short-Term Capital Gain (STCG) Tax

STCG tax is not applicable in ELSS funds as the funds are locked in for a period of three years.

Long-Term Capital Gain (LTCG) Tax

As we all know, investments in ELSS funds are exempted from tax for up to ₹1.5 lakh and this amount doesn't have to be added to one's taxable income. After exempting ₹1.5 lakh, the remaining amount will be taxed under LTCG at 10% without any indexation benefit.

Let's understand this with an example. You have invested ₹5 lakh in an ELSS fund and redeemed the entire amount after the end of the lock-in period. Here's how the tax will be calculated.

Dividend Tax

The dividend that you receive from ELSS funds is added to your income and taxed as per the slab system. For example, you get ₹10,000 as a dividend income. This entire amount will be added to your income and get subjected to tax.

ELSS funds are an ideal option for investors who are open to taking high risks and want to stay invested for a long period. Apart from saving taxes, you can also grow your wealth when you invest in ELSS funds. Since ELSS funds come with the shortest lock-in period, they are perfect for those who don’t want their money to be tied up for a long time (i.e.) 15 years.

We hope this article helped you understand all about ELSS mutual funds and how they can help you earn higher returns on your extra money. It is important to learn how liquid mutual funds will benefit you and what factors you should consider before investing in them.

If you wish to learn more about other types of mutual funds, including ELSS funds, and other types of investment instruments, such as Fixed Deposits, Digital Gold, and Smart Deposits, head over to our Blogs section. You can also check out our Calculators, where you can learn more about how much wealth you can accrue in certain years.

All geared up to start investing? Create an account with Koshex within just 60 seconds, without any paperwork. Apart from Mutual Funds, you can also invest in Smart Deposits, Digital Gold, Fixed Deposits, and more, through your Koshex Account. You can also track your expenses, build a budget, invest in hyper-personalized investment recommendations, monitor your investments, stay on top of your savings goals, and more with Koshex.

We are truly built for every aspiring & experienced Indian investor. Sign up for free today.