Table of contents
- What is an ELSS fund?
- Benefits of investing in ELSS mutual funds
- Risks of investing in ELSS mutual funds
- Factors to consider before investing in ELSS fund
- Why are ELSS funds the best tax-saving option?
- How to invest in ELSS funds?
After Budget 2023 made the new tax regime a default option, understanding ELSS (one of the best tax-saving schemes) is more important than ever before. But before you read further, know that this benefit can only be availed under the old tax regime!
This is great news because, if you are salaried, you can switch to the old tax regime at the beginning of the year. Now, let’s delve into the world of ELSS funds.
What is an ELSS fund?
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.
ELSS is an investment scheme where most of the money (about 65%) is invested in shares, and the rest is in fixed-income securities. They come with a short lock-in period of three years, so you can quickly cash in on your investment.
These 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.
Benefits of investing in ELSS mutual funds
Since ELSS is primarily an equity investment scheme, the returns are higher compared to other investments.
Investments up to ₹1.5 lakhs in these schemes is eligible for tax exemption. There is no upper capping on investment amount, while the minimum investable amount varies across fund houses.
ELSS’s investment portfolio consists of a balanced allocation to asset classes, such as equity and debt securities. It also diversifies the equity category by allocating assets to large-cap, mid-cap, and small-cap equity stocks, helping with risk mitigation.
Risks of investing in ELSS mutual funds
The performance of ELSS mutual funds is directly linked to the stock market’s performance, which can be volatile and unpredictable.
ELSS mutual funds have a three-year lock-in period, which means you cannot access your funds during this time.
The performance of ELSS mutual funds also depends on the fund manager’s ability to pick winning stocks and manage the portfolio effectively.
Factors to consider before investing in ELSS fund
Recommended Investment Horizon
Despite having a short lock-in period of three years, equity investments take around 5- years to stabilise. So, it is better to avoid keeping a short-term horizon for ELSS funds.
Comparing the fund with competitors and the benchmark helps ascertain how well the fund is performing. However, historical performances do not guarantee future returns.
The expense ratio depicts how much of your investment goes towards managing the fund. It would be best to go for funds with lower expense ratios as they can result in higher take-home returns.
The fund manager plays a crucial role in managing your funds. They should be competent and experienced in picking the right stocks and creating a strong portfolio.
Why are ELSS funds the best tax-saving option?
ELSS mutual funds have the potential to offer the highest returns among all 80C options like FDs, PPF, and NSC.
On the other hand, ELSS stands out with a lock-in period of just three years and has the potential to offer returns ranging from 15% to 18%. That’s higher than any other tax-saving investment option! Plus, equity-linked schemes’ post-tax returns are higher than any other option.
Now that you know why ELSS is the best tax-saving option, let’s compare it with other popular ones.
|Tax on returns
|5-Year Bank Fixed Deposit
|4% to 6%
|Public Provident Fund (PPF)
|7% to 8%
|National Savings Certificate
|7% to 8%
|National Pension System (NPS)
|8% to 10%
|15% to 18%
How to invest in ELSS funds?
When investing in ELSS funds, you have three options to choose from:
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.
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 Rs 5,000 are subject to a TDS of 10%.
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.
So, here it is, a guide to ELSS. Now, be a wise investor and use this great investment tool to get the best of both worlds!
Systematic Investment Planning (SIPs) and lumpsum investments are two ways of investing in ELSS funds. While SIPs involve investing small, equal amounts at regular intervals, lumpsum involves a one-time investment. SIP is suitable for risk-averse investors who want to start small.
Despite the benefits of ELSS, the main disadvantage is that the scheme invests most of its funds into equities. So, the volatility of the stock market will affect ELSS funds, too. Hence, this may not be ideal for risk-averse investors.
Both ELSS and PPF are suitable options for investors looking for tax-saving schemes. ELSS schemes offer higher returns but are subject to greater risks. PPF on the other hand, offers lower returns but is less risky, making it suitable for investors who want to restrict their risk exposure.
Fixed deposits offer lower returns but are also less risky as compared to ELSS funds. FDs are suitable for investors looking at long-term, low-risk benefits. However, both ELSS and FDs are good tax-saving investment options for investors.
An investor can invest any amount into equity-linked saving schemes. There is no upper limit on it. However, the deductions that can be claimed under 80C for tax benefits are restricted to ₹1.5 lakhs.