A Beginners Guide to ELSS Mutual Funds

ELSS or Equity Linked Savings Scheme is similar to any other diversified equity mutual fund except that it comes with a 3-year lock-in period and tax advantage. You can also invest in an ELSS fund through an SIP or Systematic Investment Plan.

ELSS mutual funds are one of the most popular types of mutual funds among investors. Apart from bringing diversification to your portfolio with a single fund, they come with an added tax advantage. ELSS funds are recommended to all new investors for its dual benefit of taxation and high returns potential.

Key Features of ELSS

  • Lock-in Period:

    All ELSS schemes come with a mandatory lock-in period of three years. You cannot withdraw the amount you have invested until your fund matures. If you have opted for the SIP route, each instalment will be locked in for three years and will mature accordingly.

  • Taxation on ELSS:

    ELSS comes with a dual tax benefit. While all equity-oriented schemes enjoy a tax rate of 10% on the long-term capital gains exceeding one lakh, ELSS also allows you to deduct your taxable income against the investments.

  • Investment Options:

    You have the option of investing in different types of ELSSs based on your preferences and requirements:

    1. Dividend:

      You can choose to receive regular dividends accrued from the sum invested. As your investment earns returns, you can receive said returns as monthly payments

    2. Growth:

      The money generated from the initial investment can be invested in more equities, and you can avail the compounded benefits at the end of the maturity period.

Advantages of ELSS?

  • Low Minimum Investment, no Maximum limit:

    You can start investing in this type of fund with as little as Rs.500, if you opt for an SIP. There is no maximum limit to the amount you can invest, but, you can avail deductions on your taxable income only up to 1.5 lakhs in a year.

  • Short Lock-in Period:

    Compared to other tax-saving investments under Section 80C of the Income Tax Act, ELSS funds have a lower lock-in period. Compared to PPF investments that come with a 15 year lock-in period, or FDs that come for a 5-year lock-in period to receive tax benefits, ELSS only have a 3-year lock-in period.

  • Dual Tax Benefit:

    ELSS is an important tax-saving instrument. It is an excellent avenue for investors who wish to pursue long-term wealth creation and avoid tax liability at the same time.

Income Tax

Under Section 80C of the Indian Income Tax Act, you can avail a deduction of up to 1.5 lakhs on your taxable income in a year against the investment made into an ELSS fund. For instance, if your taxable income before 80C is Rs 7.5 Lakhs and you invested Rs 1.5 Lakhs in an ELSS fund, your taxable income can be deduced to Rs 6 Lakhs (Rs 7.5 Lakhs - Rs 1.5 Lakhs).

Long Term Capital Gains Tax

Apart from deductions under Section 80C, ELSS funds attract a Long-Term Capital Gains Tax, on the account of being equity-oriented funds. Long-term capital gains exceeding Rs 1 lakh a year are taxable at the rate of 10%. For example, if you gain 1.5 lakhs from your investment, the tax will only be applied on 50,000 at the rate of 10%

Higher Returns Potential

Compared to other tax-saving instruments, ELSS mutual funds are known for their higher return potential. Here are a few reasons for its high-return potential:

  • Equity Exposure:

    Being an equity-oriented fund, all ELSS funds have to maintain at least 65% exposure to equity. While this increases their risk level, it also helps them to generate better returns than other types of tax-saving instruments potentially.

  • Diversification:

    These funds are diversified to mitigate risk. Mutual funds are always subject to market conditions and developments. Diversification is the process of spreading the investment over a range of other investment options. This ensures that if one asset is performing weakly, the investment is not tied down.

  • Professional Fund Management:

    Professional fund managers manage ELSS mutual funds. They are informed about market conditions and invest their money in a planned and systematic way to ensure maximum returns. This type of fund is great for novice investors who want to reduce tax liability.

  • Investment Discipline:

    The SIP route inculcates investment discipline. A disciplined investor plans out their investments, which is why the SIP option is popular. The lock-in period also ensures that you do not withdraw the amount and that the money stays invested.

How to Invest in ELSS?

You can invest in these funds, both online or offline:

  • Online:

    If you have an online trading account, you can invest in these schemes online. You must open an account on Mutual Fund Utilities. MFU is a platform that aggregates all the schemes offered by different Asset Management Companies. You may also sign up for these schemes separately with different AMCs.

  • Offline:

    You can sign up for these types of funds offline by submitting an application form available from any distributor or AMC office. All entry loads are abolished, but you might still need to pay a service fee if you go through a distributor.

    ELSS funds are equity-linked and, hence, include a certain level of risk for high return potential. The SIP option allows you to invest systematically in instalments that still gives you the tax benefits of this kind of fund without having to commit a lump sum at one go. This option also reduces the buy-in cost for these schemes.

ELSS funds are an excellent option for first-time investors. Apart from tax benefits, these funds also have the potential of giving a higher rate of returns compared to other tax-saving options under 80C.

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