What is an ELSS fund?
To begin with, ELSS funds are Equity Linked Saving Schemes which is a type of mutual fund investing mainly in equities and equity-related instruments. ELSS mutual funds are known for their tax-saving benefits of Rs. 1.5 lakhs in a financial year. So, the investments up to Rs. 1.5 lakhs that you make in any ELSS fund will be exempted from income taxes or deducted from your taxable income. This is as per section 80C of the Income Tax Act, 1961. However, to avail of this benefit you need to be under the Old tax regime as new and the default tax regime doesn’t allow any deductions as per this section.
What are the features of ELSS funds?
The features of the ELSS scheme which you need to know about before taking any call about the investment are –
Usually all tax-saving investment schemes have five years or higher lock-in period which makes it difficult for investors. However, an equity-linked savings scheme has only three years of lock-in which makes the life of the investors easier. The shorter lock-in period helps investors in utilising the money right after three years without giving up on any tax benefits.
ELSS mutual funds offer comparatively higher returns than the regular tax-saving options such as bank FDs or recurring deposits. This is because the underlying asset of the fund is stocks or equities to be precise which generates higher returns than fixed-income instruments. However, the risk factor is also high in ELSS compared to fixed-income tax savings instruments.
With ELSS funds, you get SIP and lump sum investment options, both options are available so that investors can pick their choices. With the SIP option you can invest a small amount into the fund and see whether it is working for you or not and if you want to invest a lump sum amount and let it grow over time, you can do that as well. With the SIP option, you can start investing in these funds with even Rs. 500 per month which is beneficial for newbie investors and retail investors with less disposable income.
No investment ceiling
While you can start with the nominal amount to start investing in these funds, you can invest as much as you want. There is no ceiling or cap on the investment amount. This helps people save some and invest more, and in the long run, accumulate more wealth.
The most talked about feature of these funds is of course the tax benefit. Suppose you are investing Rs. 10000 in a month into an ELSS scheme via the SIP route, so yearly your investment will be Rs. 120000. As per section 80C of the Income Tax Act, you are eligible for deduction from your taxable income up to Rs. 1.5 lakhs, so, you can easily deduct this 1.2 lakhs of investment into ELSS from the taxable income and reduce your tax burden. The profits of ELSS funds are taxed as per capital gain rules and also enjoy long-term capital gain benefits if the investor stays invested in the fund for more than a year.
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How ELSS funds work?
ELSS funds invest in equities and equity-related instruments of companies which are listed on the stock exchange. It invests across the market capitalisation of the companies whether large, medium or small-cap companies and also across different sectors. The objective of ELSS funds is to generate the maximum possible returns to offer appreciation in your capital investment in the long run.
The fund managers of these funds pick underlying stocks and other securities after detailed research of the companies. As per AMFI, the fund manager needs to invest at least 80% of the asset under the management of the fund into equities or equity-related instruments. This is one of the reasons why ELSS funds offer higher returns compared to most tax-saving investment options.
Who should invest in ELSS mutual fund funds?
The ideal investors for equity-linked savings schemes are –
People who are new to the investment arena and looking for equity investment options, for them ELSS can be one of the best investment options. There are different reasons behind it, first, they can start their investments with smaller amounts, then the lock-in period is less and also they can save taxes.
ELSS funds are suitable for salaried people as they can start a SIP and automate their investments and save a portion of their salary every month without any hassle and also earn good returns on the same and reduce tax burden at the same time. Usually, employees have PPF where they contribute and thus get tax benefits from there as well, however, for higher returns on investment, salaried employees can go for ELSS funds where they do not have to put their brain and eyes on the computer screen tracking stock market but also get the returns from the stocks or equities to be precise.
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Comparison of ELSS with Other Tax-Saving Instruments
The above table points out the difference between all these tax-saving schemes in India. As you can see ELSS mutual funds are one of the highest return-generating instruments with the lowest lock-in period.
Why are ELSS Mutual Funds the Best Tax-Saving Option?
Tax savings investment options are usually fixed-income investment options like PPF, pension schemes, and government saving schemes, which offer steady returns but the rate of return is usually between 6% and 9%. This is where ELSS funds stand out for the following reasons.
- These funds being tax-saving investment options in your investment portfolio, don’t keep you waiting for 10-15 years to realise the amount you have accumulated.
- You can invest as much as you want in these funds most of the other tax-saving options have a cap on investment amount per financial year
- If you are all under the highest tax saving slab which is 30% as per current tax slabs, then you can save up to Rs. 46800 in a financial year just by investing in the ELSS scheme.
- Another thing to consider is the SIP route benefit. Most of the other tax-saving investment options usually ask for lump sum investment while in ELSS, you can go for periodical smaller investments via the SIP route.
- Finally, other investment options which offer tax savings don’t offer returns that can expect from equity investments.
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What are the factors to consider before investing in ELSS?
Since there are so many ELSS funds in the mutual fund arena, you must pick the right fund for your portfolio. To choose the right fund you need to evaluate the following factors –
Every ELSS fund offers different returns so, you need to evaluate which fund is offering what returns. Compare the returns with other ELSS funds and also with other tax-saving options. You can compare the three-year return but going for the long-term returns will be wiser. If ten years' returns are available for the funds, compare them, or check for five-year returns.
Returns are subjected to risk, and the risk of the fund must be in sync with your risk profile. If you are a risk-taker, you can invest in high-risk funds where the return potential is higher as well. However, if you are risk averse, then you can look for ELSS funds that offer medium return but the risk profile is lower. One thing to note here is that these funds are generally riskier than other tax-saving instruments as these funds invest in equities. So, if you are looking for risk-free tax-saving investments, then this fund is not for you.
Rank in the category
One of the best ways to evaluate a fund’s performance within the category is by checking its rank. You can check the category average and rank within the category of the funds and evaluate them accordingly.
Fund manager’s profile
The fund manager is the person who takes care of the fund by choosing the right underlying assets and allocating the fund in the right proportion and rebalancing the portfolio as per changes in market and asset allocation. Thus, you need to know at least a bit about the fund manager’s profile, what kind of funds he has expertise in and experience years and knowledge.
History of the fund house
Equally important is the fund house’s history. Not all fund house offer similar kind of funds, some charges higher expense ratio or don’t offer good returns on any of their schemes. So, you need to evaluate that as well before putting your money into any ELSS scheme of any fund house.
Again coming back to the individual fund itself, you need to check the different financial ratios apart from the returns for understanding how reliable the fund is. For instance, you can check the downside risk, the beta of the fund, the Sharpe ratio and others to evaluate the risk profile of the fund and overall returns.
Expense ratio and Exit Load
Finally, you need to check the expenses which includes the expense ratio that gets adjusted from the NAV of the fund. The higher the expense ratio, the higher will be the negative impact on your NAV. However, a higher expense ratio also means active funds or Alpha funds which are managed proactively and generate very high returns. However, you need to see if the expense ratio is diluting the higher returns, then no point in taking such a huge risk. Also, exit loads are important as if you are planning to withdraw any amount from the fund or redeem it completely, then you need to check the tenure till when exit load is applicable as exit load can also reduce your profits.
Why Should You Invest in ELSS Mutual Funds?
If you are still in dilemma about whether to go for ELSS investment or not then here are certain benefits of investing in these ELSS mutual funds you cannot ignore –
- Apart from ELSS tax benefits from section 80C of the Income Tax Act, 1961, these funds also enjoy long-term capital gain taxes advantages after just one year of investment. This is one of the most important reasons for investing in an equity-linked savings scheme if you are looking for tax savings from ELSS.
- Then comes the SIP benefit which helps retail investors and new investors invest in these funds even with a nominal amount like Rs. 500 a month. While there is no cap on the investment amount, you can invest as much as you want. However, tax benefit under section 80C is available only up to investments worth Rs. 1.5 lakhs in a financial year.
- ELSS mutual funds are the only equity savings or investment option that offer tax-saving benefits.
- You can redeem your investments after a three-year or lock-in period which is the shortest among all other tax-saving instruments.
To conclude, ELSS funds can be suitable for new investors looking for higher returns than traditional tax-saving instruments and shorter lock-in periods and with moderate risk appetite.