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Equity Linked Saving Scheme (ELSS) Mutual Funds

Equity Linked Saving Scheme (ELSS) Mutual Funds

Equity Linked Saving Scheme

1. What is an Equity Linked Savings Scheme (ELSS)?

An Equity Linked Savings Scheme (ELSS) is a diversified equity mutual fund that gives you a dual benefit of tax saving with the growth potential of equities. ELSS allows an individual or HUF a deduction from the total income of up to Rs. 1.5 lacs under Sec 80C of Income Tax Act 1961.

However, unlike other tax-saving investments, Equity Linked Saving Scheme has a lock-in period of just 3 years! You can invest in ELSS through a Systematic Investment Plan (SIP) and also a lump sum. Investing through a SIP also gives you the benefit of rupee-cost-averaging and compounding, which helps you ride over market volatility over the long term. ELSS aims to beat rising inflation in the long run by investing primarily in equities.

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2. What are the features of ELSS funds?

The main features of ELSS funds are

  • ELSS mutual funds’ asset allocation is mostly made towards equity and equity-linked securities such as listed shares.
  • The ELSS funds invest in equity in a diversified manner- across different market capitalizations, themes and sectors.
  • Investments in ELSS are eligible for a tax deduction from total income up to Rs. 1.5 lacs under Sec 80C of Income Tax Act 1961
  • ELSS funds come with a lock-in period of three years, and there are no provisions to make a premature exit.
  • ELSS funds are the only tax-saving investment with the potential to offer inflation-beating returns.
  • The gains from ELSS funds are treated as capital gains. Short-term capital gains (if the units are sold before one year) in ELSS funds are taxed at the rate of 15% plus 4% cess. Long-term capital gains tax in ELSS funds is 10% + 4% cess provided the gain in a financial year is over Rs 1 Lakh. Long-term capital gains up to Rs 1 Lakh are totally tax-free.
  • You can invest any amount in ELSS, there is no upper capping, while the minimum investable amount varies across fund houses.
  • You can also invest in ELSS through the Systematic Investment Plan (SIP) mode.

3. What are the advantages of ELSS funds?

Some of the main advantages of ELSS are as follows:

  • Investment in ELSS could provide capital growth over the long term since they invest in the equity market.
  • Equities over a longer time frame have the potential to outperform traditional tax-saving instruments.
  • Investments made in ELSS are eligible for tax deduction up to Rs.1,50,000 under Section 80C of the Income Tax Act, 1961.
  • ELSS has the lowest lock-in period of 3 years as compared to other investment avenues
  • Investors can opt for the dividend option and look forward to some cash flows even during the lock-in period.
  • Long-term capital gains from ELSS up to Rs 1 Lakh are totally tax-free.
  • Get your investment proof instantly.

4. What are the benefits of ELSS compared to other 80C tax-saving investment options?

Like any other tax saver investment option, ELSS mutual funds also provide tax deductions of up to ₹ 1,50,000 a year under the provisions of Section 80C of the Income Tax Act, 1961. This helps you save up to ₹ 46,800 a year in taxes.

With so many tax-saving options, it’s easy to get confused. Let’s compare the benefits.

Features PPF NSC Tax saver FD ULIP NPS ELSS
Lock-in-period 15 yrs 5 yrs 5 yrs 5 yrs Till retirement 3 yrs
Returns 7.% 6.8% 5.4% to 6.5% Mkt Linked Mkt Linked Mkt Linked
Minimum Investment ₹ 500 ₹ 100 ₹ 1,000 Depends on premium ₹ 500 ₹ 500
Risk rating Low Low Low Moderate to high Moderate to high Moderate to high
Potential for inflation-beating returns No No No Yes Yes Yes
Tax on returns No Yes Yes No Partially taxable Partially taxable

5. Who should invest in ELSS funds?

ELSS is an ideal investment option for the following type of investors.

  • Salaried Individuals – Investing in ELSS funds in a lump sum or through SIP will help you with the upside of extraordinary returns from equities and also will provide you with the benefit of tax deduction under sec 80C of the Income Tax act. ELSS is the best option for those who want to balance out risk & return on their investment portfolio.
  • Other tax assessees– Other individual tax assessees, including self-employed people, can find ELSS funds as the best investment option due to the benefits upside of higher long-term equity returns and tax deduction benefits under sec 80C. While Unit Linked Insurance Plans (ULIPs) and the National Pension Scheme (NPS) also do the same, they have a higher lock-in period.
  • First-time investors– ELSS funds are the best choice for those who consider investing in mutual funds for the first time since in addition to tax benefits you get a flavour of equity investing and mutual funds. Yes, equity investments do carry a higher risk, but that is generally over the short term. If you invest for more than five years, the risk is much lower.

6. What is the benefit of investing in ELSS through a Systematic Investment Plan (SIP)?

A good way to invest in ELSS is through a Systematic Investment Plan (SIP). SIP helps you take advantage of market ups and downs through rupee cost averaging. This is a process through which a fixed amount is invested each month. When markets are down, you end up buying more units at the same price, and when the markets are up, you buy fewer units. Over time, this results in averaging out the cost per unit, than if you buy all the units at one go.

7. Things to know before investing in ELSS

  • ELSS carries a moderately high risk

ELSS, being an equity-oriented scheme, has a minimum of 80 per cent exposure to equity and equity-related instruments. This also means that it contains a moderately high-risk-bearing scheme that has your investment money exposed to the vagaries of the market.

  • Short lock-in period

ELSS funds come with a three-year lock-in period, shorter than some other investment options such as fixed deposits (FDs) and Public Provident Fund (PPF). This means that you cannot redeem your holding until the end of the lock-in period.

  • Returns are not guaranteed

ELSS has the potential for higher returns compared to traditional investment products. However, ELSS is subject to market risks and considering the market is cyclical, the rise and fall of equities are temporary. Even though you purchase the best ELSS funds as per their past performance, these may not guarantee higher returns in future. As mentioned above, it’s best to stay invested beyond the lock-in period for better returns.

  • Tax implications on ELSS funds

You will incur 10% tax plus 4% cess on Long Term Capital Gains (LTCG) exceeding Rs. 1 lakh per annum. Short-term capital gains (if the units are sold before one year) in ELSS funds are taxed at the rate of 15% plus 4% cess.

  • Lumpsum or SIP

You can invest in ELSS funds either with a lump sum amount or via the SIP route. If your risk appetite is not high, it might be better to invest via the SIP route.

  • Fund Performance

You need to compare the fund’s performance with that of its competitors & benchmark it to know if it has shown consistent performance in the past. If a fund outperforms its benchmark or competitors, then the fund delivers high returns. Also, you need to check the history of the fund house, the fund expense ratio and the fund manager’s experience before selecting an ELSS fund.

8. Frequently Asked Questions (FAQs) on ELSS

What are ELSS mutual funds?

If you are opting for ELSS, you already know that it is an open-ended mutual fund scheme that invests in equities and equity-related instruments. An Equity Linked Savings Scheme (ELSS) is a diversified equity mutual fund that gives you a dual benefit of tax saving with the growth potential of equities. ELSS allows an individual or HUF a deduction from total income of up to Rs. 1.5 lacs under Sec 80C of Income Tax Act 1961.

When can you redeem your ELSS investments?

ELSS has a lock-in period of three years. This means you cannot withdraw your money before the said tenure ends. However, ELSS has the shortest lock-in period as compared to other similar tax-saving investments such as 5-year Fixed Deposits (five years), National Savings Certificate (five years), and Public Provident Fund (15 years), etc.

Are partial withdrawals from ELSS possible?

The answer is no! You will stay invested in the fund for at least three years. With equities, the longer you stay invested, the more wealth you may build. How much you can create also depends on how much you invest.

What is the minimum and maximum investment amount for ELSS?

There is no upper limit for investing in ELSS or any other mutual fund type. You can invest as much as you want and let your money compound and grow. The minimum investment amount for ELSS varies across fund houses. Usually, it is ₹ 500.

What is a lock in period?

A lock-in period means that the funds invested cannot be withdrawn before the expiry of the respective time period, under normal circumstances. All tax-saving investments have lock-in periods ranging from 3 to 15 years. ELSS funds have a lock-in period of 3 years, the shortest among all the instruments eligible for tax saving under Section 80C.

How risky it is to invest money in ELSS? Are such funds subject to market fluctuations?

ELSS could be volatile in the short run and get affected by market changes. However, such investments tend to be rewarding in the long run. So, the key here is to stay calm and have a long-term investment perspective.

What are the average returns that ELSS offer?

The average returns offered by ELSS over the last 10 years is about 15%*. You can expect between 12-15% returns on average when you invest in ELSS. This is much higher than other 80C tax-saving investments such as 5-year Fixed Deposits (5-8%), National Savings Certificate (6.8%**), Public Provident Fund (7.1%**), etc.

*Source: Economic Times **Current rates

What is the risk associated with ELSS?

ELSS funds are essentially diversified equity funds and carry a similar risk-return profile as equity funds as they both invest in the equity markets. ELSS funds have a 3-year lock-in period from the date of investment during which the money from the fund cannot be taken out.

What is the tax benefit for investment in ELSS?

Investments get tax deduction under Section 80C of the Income Tax Act, 1961 up to ₹. 1,50,000.

What options should one invest for - growth or dividend?

You can opt for the growth or dividend pay-out option. The growth plan is the cumulative option under which your investment will keep growing till you redeem it. In the dividend plan, the fund declares dividends depending on various factors like appreciation, availability of surplus, etc.

9. Conclusion

Overall, ELSS is a good investment vehicle to save tax as well as to build wealth over the long term. If you really want to reap the rewards of your tax-saving investments, think beyond the lock-in period of three years. As per the market information, equities have delivered relatively higher returns and aided in capital growth over the long term.

10. ELSS SIP Calculator


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Expected Annual Returns is required

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The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Unifinn Capital Global is not liable for any decision arising out of the use of this information.

Mutual fund investments are subject to market risk. Please read the scheme-related documents carefully before investing.

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