ELSS Mutual Funds: Definition, Features and Working

Rising income levels often push individuals into higher tax brackets, leaving limited room to plan taxes without compromising long-term financial goals. This challenge makes understanding what is ELSS especially relevant today. ELSS Mutual Funds address this gap by combining tax benefits under Section 80C with equity-based growth. Notably, ELSS assets under management crossed ₹2.5 trillion in 2025, displaying their growing role in tax planning. This blog explains how ELSS works and why it merits closer attention.

What are ELSS Funds

ELSS stands for Equity Linked Savings Scheme, which is a fancy way of saying that these funds invest most of their money in stocks and securities.

So, what exactly is an ELSS fund? Well, it’s an investment scheme where most of the money (about 80%) is invested in shares, and the rest is in fixed-income securities. What’s interesting about ELSS funds is that they come with a short lock-in period of three years, so you can quickly cash in on your investment.

And the best part about ELSS funds is that they are tax-saving equity mutual funds. By investing in them, you can claim a tax rebate of up to Rs 1,50,000 and reduce your taxable income under Section 80C of the Income Tax Act. That means you can keep more of your hard-earned money in your pocket!

Features of ELSS Mutual Funds

ELSS mutual funds possess several different features which make them a good investment options, which include:

1. Dual Benefit

ELSS funds stand apart by offering twin advantages that few investment instruments provide. Investors receive tax deductions up to ₹1.5 lakh under Section 80C and through LTCG tax exemptions. This combination addresses both immediate tax liability reduction and long-term financial growth objectives within a single investment vehicle.

2. Returns can beat inflation

Traditional savings instruments often struggle to outpace inflation, eroding purchasing power over time. ELSS funds invest predominantly in equity and equity-related instruments, providing market-linked returns with the potential to deliver inflation-beating performance. Whilst returns remain subject to market fluctuations and carry inherent risks, the equity exposure positions these funds to capitalise on economic growth prospects over extended periods.

3. Managed by Financial Experts

Professional fund managers oversee ELSS portfolios, bringing extensive market knowledge and analytical capabilities to investment decisions. These experienced professionals conduct thorough research, monitor market trends, and strategically allocate assets across various sectors, ensuring informed choices that align with the fund’s objectives whilst managing risk exposure effectively.

4. Shortest lock in period

Among tax-saving options available under Section 80C, ELSS features the briefest mandatory lock-in of just three years. This period ensures disciplined investing whilst preventing impulsive withdrawals, yet provides considerably more liquidity compared to alternatives.​​​​​​​​​​​​​​​​

How Does ELSS Funds Work?

ELSS works through a simple process that pairs regular investment contributions with mandatory holding requirements.

• Two choices for putting money into ELSS funds: invest a large amount in one go, or set up monthly contributions through a Systematic Investment Plan that suits your income pattern and budget constraints.
• Once the investment is made, the fund manager puts at least 80% of the collected capital into stocks and related securities, spreading these investments across various industries and companies of different sizes to reduce concentration risk.
• The investment stays locked for three years from the date you put the money in, and the fund house will not allow any withdrawals during this time.
• For those investing monthly through SIPs, each contribution starts its own three-year countdown from that specific payment date.
• The fund manager watches market movements throughout this period and shifts money between different stocks to pursue higher returns whilst trying to limit potential losses.
• The returns fluctuate based on how the stock market performs, which differs fundamentally from fixed-return products like bank deposits or government schemes that promise specific rates. Benefit of tax deductions on taxable income by up to ₹1.5 lakh under Section 80C in the year you make the investment.
• After the mandatory three year lock-in, the option to either redeem their units partially or fully, or continue holding them for potential further appreciation. 
• The fund continues to remain invested in equities even after the lock-in ends, so you can continue gaining from equity market growth if you decide not to withdraw immediately.​​​​​​​​​​​​​​​​

How Should You Invest in an ELSS Fund?

When investing in ELSS funds, you have three options to choose from:

1. Growth option

In this option, you won’t receive dividends. Instead, you’ll get all your gains at the time of redemption. This approach can be beneficial if you’re looking for long-term growth, but it’s subject to market risk.

2. Dividend option

With this option, you’ll receive periodic dividends. However, keep in mind that these dividends are taxable according to your tax slab. Moreover, dividends over ₹5,000 are subject to a TDS of 10%.

3. Dividend reinvestment option

This option allows you to reinvest your dividends to increase your NAV. This can be especially beneficial when the market is up and likely to continue rising.

Why should you invest in ELSS Tax Saving Mutual Funds?

ELSS tax saving mutual funds are often chosen by investors who want tax relief without locking money away for too long.

• Tax benefit: Investments qualify for deduction within the overall 80C limit, helping lower taxable income for the year.
• Exposure to equities: Since ELSS invests largely in stocks, it offers better growth possibilities compared to fixed-return tax-saving options, especially over longer periods.
• Shorter lock-in: The three-year lock-in is relatively brief when compared to other tax-saving instruments, giving earlier access to invested money.
• Forced investing discipline: The lock-in period prevents emotional exits during market declines, allowing investments time to recover.
• Handled by professionals: Fund managers take care of stock selection and portfolio changes, reducing the need for active involvement.

Taxation Rules of ELSS Funds

The applicable tax rules on ELSS funds are as follows:

1. Tax deduction on investment: The invested amount is eligible for Section 80C deduction, subject to the overall annual limit.
2. Capital gains taxation: Returns earned after the lock-in are treated as long-term capital gains and taxed at 12.5% rate.
3. Exemption limit applies: Long-term gains up to the annual exemption threshold remain tax-free across equity investments.
4. SIP lock-in works differently: Each SIP instalment completes its own three-year lock-in, which means redemptions become available in phases.
5. Dividend tax treatment: Any dividends received are added to total income and taxed according to the applicable slab rate.
6. No tax deducted at source: There is no TDS on capital gains for resident Indians; however, a 10% TDS applies to dividend income if it exceeds ₹5,000 in a financial year. 

How to Choose the Best ELSS Mutual Fund?

Picking an ELSS fund in 2026 shouldn’t be only about saving tax. The money stays locked in for three years, so the choice needs a bit more thought.

1. Go for consistent returns

Markets have moved up and down a lot in recent years, so it’s better to look at how a fund has performed over longer periods like three or five years. Funds that have managed to stay ahead of their benchmark during different market phases usually handle pressure better. As on Jan 26, 2026 ELSS fund category have shown returns as follows:

Time period	Returns (in %)
3-year	15.07
5-year	15.03
10-year	14.56

2. Check the risk-reward ratio

Since ELSS funds invest in shares, ups and downs are normal. Some funds swing more than others. Simple risk measures like standard deviation and the Sharpe ratio help understand how smoothly a fund has delivered returns. A higher Sharpe ratio generally means the fund has managed risk more efficiently.

3. Evaluate the portfolio mix

All ELSS funds follow different styles. Some stick mostly to large companies, while others take more exposure to mid and small companies. Looking at the portfolio gives a clearer picture of this. If other investments already lean heavily toward large-cap funds, a more flexible ELSS may help balance things out.

4. Expense ratio and fund manager 

Higher expenses slowly eat into returns, especially over time. Direct plans usually keep costs lower. It also helps to check how long the fund manager has been with the scheme. Funds run by the same team for years often follow a clearer and more stable approach.

Lastly, before investing, running the numbers through an ELSS calculator can help set expectations. It gives a simple idea of how a SIP or lump sum might grow over time and whether it fits long-term plans.

Conclusion

Knowing what is ELSS helps look at tax saving from a broader lens rather than as a last-minute task. ELSS mutual funds combine tax benefits with equity participation, along with a short lock-in compared to other options. When chosen carefully, they can support disciplined investing while staying aligned with long-term financial goals instead of just yearly tax deadlines.

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