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Thinking of Investing in Best Tax Saving Mutual Funds? Here's a Detailed Guide

Get Started with Tax Saving Mutual Funds

How to save maximum tax is a question that is on everyone's minds, investors, or not. An effective way could be tax-saving mutual funds. The key, though, is to invest wisely. The right mutual funds not only help you save tax but can also ensure significant returns. Here is a detailed guide on tax saving mutual funds to help you make an informed decision.

If you are looking for a reliable investment scheme, which also gives you tax deductions, you can opt for the best tax saving mutual funds. Though there are several investments eligible for tax deductions, ELSS has gained immense popularity. Know more.

An Introduction to Tax Saving Mutual Funds

Mutual funds offer a variety of options to investors, which is why more and more people are investing in it. One of the attractive funds is the tax-saving mutual funds, which offers a win-win situation for everyone. It is ideal for medium-level investors with low-risk tolerance, tax saving mutual funds, as it helps them get tax benefits under Section 80C of the Indian Income Tax Act, 1961.

ELSS or Equity Linked Saving Schemes form the major crux of tax saving funds. As the term suggests, ELSS invests in equity assets and can help you get a deduction of INR 1.5 lakhs under 80C. What you need to note is that ELSS has a lock-in period of three years.

Types of ELSS

    There are three types of schemes:

  • Dividend Scheme
    1. Provision for an extra income from time to time

    2. Dividends received are not taxable

    3. Can be withdrawn or re-invested

    4. Ideal for those looking for a steady income

  • Growth Scheme
    1. Capital appreciation to be redeemed at scheme maturity

    2. Ideal for those looking at maximising their investment

Key Features of Tax Saving Mutual Funds

  • No upper limit for investing and the lower limit is as low as Rs. 500

  • There is no LTCG tax on capital appreciation of up to Rs 1,00,000

  • Prone to market risks as these are equity funds

  • Open-ended schemes

  • Entry and exit loads applicable (charges levied upon purchase, sale, or transfer)

Benefits of ELSS Funds

  • Benefits of ELSS Funds

  • Helpful for medium-term and long-term financial goals

  • Allow ease of investment through SIPs or Systematic Investment Plan (monthly investments)

  • Provision for earning dividends regularly and re-investing it

  • The shortest lock-in period of only three years compared to other tax-saving schemes

  • Open-ended nature allows investment all year through

  • A diverse portfolio of ELSS ensures minimal risks

  • ELSS funds are managed by professional fund managers and thus benefit even those who do not have in-depth knowledge about the market

  • Ideal for beginner investors as the lock-in period is only three years, help save taxes, and come with an excellent return potential, thus offering a friendly introduction to mutual fund investments.

Why ELSS Fares Better Than Other Tax Saving Schemes

Several tax-saving investment schemes such as PPF or Public Provident Fund, Fixed Deposits, NSC or National Savings Certificate offer tax benefits. While each of these schemes offers several advantages, ELSS is the best tax saver fund there is. Take a look.

  • Shortest Lock-in Period:

    Most tax-saving instruments have a lock-in period. For example, PPF has a 15-year-period, FD has five, and NSC has a lock-in period of 5 to 6 years. The lock-in period of ELSS is three years only, thus making it a more convenient option than other schemes.

  • High-return Potential for A Longer Period:

    ELSS investment in the equity markets has the potential to fetch you higher returns if invested for an extended period say ten years. Even for short terms, it can be lucrative. For example, in addition to claiming tax returns up to Rs. 1, 50,000, the capital gains the investor earns are also tax-free. Thus, ELSS tends to be more profitable for an average investor.

  • Provision for Long-term Investment:

    ELSS funds are quite flexible in terms of investment. If your funds are performing well and you wish to continue the investment, you can do so even after the lock-in period. Well-diversified ELSS funds could be an ideal investment for an extended period and prove to be the best tax saver fund.

  • SIP Option Benefits All:

    Systematic Investment Plan or SIP allows investors to invest an amount every month in their ELSS funds. Thus, those who do not have the means to go for high financial investments can benefit as well.
    Another advantage of the SIP option is that it inculcates financial discipline even in hesitant investors.

Tips to Choose The Best ELSS Funds

There are many ELSS funds in the market. It can be a challenge in choosing one that aligns with your goals. Here are a few pointers to help clear the way.

  • Look for Consistency And Not Top Performance:

    You may look at a list of top-performing funds and equate the top ranking as the best tax saving MF. For ELSS funds, such an approach can be counter-intuitive. This is because the fund that is performing well today may hit the dust in the subsequent period. Therefore, you should look for funds that have performed consistently in the negative as well as positive market phase.

  • Check Out The Risk To Reward Ratio:

    ELSS funds are equity-based mutual funds, so there is always a risk. Before investing in a particular scheme, you should find out the returns provided to you at the expense of the risk. It means the higher the risk, the higher should be the return.

    Find the Sharpe and Sortino ratios and compare them with its benchmark index. Though the funds with higher Sharpe ratio are regarded as the ones yielding better risk to reward ratio, there could be misleading ones as well.

  • Check The Diversification of The Funds:

    ELSS funds have high diversity considering these funds are invested in many securities to reduce the risks. Still, do find about the fund composition and see if the risk profile of the ELSS fund matches your risk tolerance.

    As you can see, ELSS funds are ideal in many ways and thus one of the best tax saving mutual funds in India. Since there are different parameters such as risk, lock-in period, and a variety of ELSS fund options, this guide can help you understand the path to ELSS investment better. Educating yourself will help you get the best deal.