Home » Mutual Funds » The major differences between mutual funds and ELSSs

The major differences between mutual funds and ELSSs

Mutual funds are quite popular in India. Lots of investors use mutual funds to diversify their portfolios across different asset classes without taking on too much risk. The industry has also evolved over the years to include mutual funds targeted towards retirement, debt, or a combination of equity and debt.

ELSSs, however, are not as well known as mutual funds. These are quite similar to mutual funds in the sense that they’re equity savings schemes, but the difference comes when you include capital gains taxes.

In this article, we’re going to talk about both these instruments separately first and then explore the main differences between the two later.

What are mutual funds?

Mutual funds are investments that pool money from lots of investors and deploy that capital in a diversified portfolio of stocks, bonds, or other securities. 

These funds are managed by professional fund managers who make investment decisions on behalf of the fund’s investors. The primary objective of mutual funds is to provide investors with an opportunity to achieve their financial goals, such as long-term wealth creation, retirement planning, or generating income.

Corresponding to achieving these goals in a timely manner, fund managers come up with a strategy that best achieves these returns goals with appropriate risk.

Here is a snapshot of the different types of mutual funds you could invest your money into:

  • Equity funds: These funds primarily invest in stocks and aim to generate capital appreciation. They are usually held for the long term.
  • Debt funds: These funds invest in fixed-income instruments like bonds and are suitable for investors seeking regular income. These aim to preserve capital more than appreciating them. Debt funds are more suitable for investors with sizable capital seeking to protect their money from inflation rather than growing it aggressively. These could also be used for diversification purposes with higher-risk equity funds.
  • Balanced funds: These funds invest in a combination of equities and debt instruments, providing a balance between growth and stability.
  • Money market funds: These funds invest in short-term debt instruments and are considered low-risk investments for preserving capital in the extreme short term (think a few days to a few weeks).

Some of the top mutual funds in India, based on their performance and assets under management, include:

  • HDFC Top 200 Fund
  • Axis Bluechip Fund
  • SBI Bluechip Fund
  • Mirae Asset Large Cap Fund
  • ICICI Prudential Bluechip Fund

What are ELSSs?

ELSS (Equity Linked Savings Scheme) funds are a type of mutual fund in India that offer tax benefits under Section 80C of the Income Tax Act. 

These funds are primarily equity-oriented, with a minimum investment of 65% in stocks and equity-related instruments. ELSS funds are designed to encourage long-term investment and wealth creation. Apart from this, these funds also generate income in a way that provides tax benefits to investors.

Unlike regular mutual funds, ELSS funds have a lock-in period of three years, meaning investors cannot redeem their investments before that period. 

However, this lock-in period serves as a disciplined approach to long-term investing and helps you avoid the temptation of making impulsive decisions based on short-term market fluctuations.

Some of the biggest allures of ELSSs are the benefits they offer to investors that are not offered in mutual funds. These include:

  • Tax benefits: Investments in ELSS funds are eligible for deduction from taxable income up to ₹1.5 lakh under Section 80C of the Income Tax Act. This deduction can significantly reduce an individual’s tax liability, making ELSS funds an attractive investment option for tax planning.
  • Higher potential for returns: Since ELSS funds usually invest a higher proportion of their capital into equity (by mandate), they also have a higher potential for returns compared to debt or money market funds. You must realise, however, that this also means that these funds take on more risk to generate these returns.

Some popular ELSS funds in India include:

  • Axis Long Term Equity Fund
  • Mirae Asset Tax Saver Fund
  • ICICI Prudential Long Term Equity Fund (Tax Saving)
  • DSP Tax Saver Fund
  • SBI Long Term Equity Fund

Differences at a glance

FeatureELSSMutual Funds
Primary ObjectiveTax Savings & Capital GrowthInvestment Goals (Income, Growth, etc.)
Tax BenefitUp to ₹1.5 lakh deduction under Section 80CNo tax deduction benefit
Lock-in PeriodMinimum 3 yearsVaries (Open-ended: No lock-in; Close-ended: Pre-defined lock-in)
Investment TypePredominantly EquityEquity, Debt, Hybrid (mix of Equity & Debt)
LiquidityLower (due to lock-in)Higher (depending on fund type)
Risk-Return ProfileGenerally Higher Risk & Higher Potential ReturnVaries depending on fund type (Equity = Higher Risk/Return, Debt = Lower Risk/Return)

Frequently Asked Questions

Can I invest in ELSS funds through SIPs?

Yes, just like mutual funds, ELSSs also allow you to invest a fixed sum of money into the fund at regular intervals through a systematic investment plan.

Is there an age limit for investing in ELSS funds?

No, there is no age limit for investing in ELSS funds. Both salaried individuals and self-employed individuals can invest in ELSS funds, subject to the applicable tax laws and regulations.

Can I redeem ELSS funds before the lock-in period of three years?

No, you cannot redeem your investments from ELSS funds before the lock-in period of three years. However, in case of specific contingencies like the death of the investor or the investor becoming a person with disabilities, premature redemption may be allowed.

Are ELSS funds more suitable for long-term or short-term investments?

ELSS funds are designed for long-term investments. While they offer tax benefits, their equity exposure and lock-in period make them more suitable for investors with a longer investment horizon and a higher risk appetite.

Can I invest in ELSS funds through multiple folios or schemes?

Yes, you can invest in ELSS funds through multiple folios or schemes. However, the total deduction under Section 80C, including investments in ELSS funds and other eligible instruments, should not exceed the maximum limit of ₹1.5 lakhs in a financial year.

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