ELSS Mutual Funds – Meaning, Tax Benefits & How to Invest

Equity-Linked Savings Schemes (ELSS): A Comprehensive Guide

Equity-Linked Savings Schemes (ELSS) are known to be the top funds to invest in for tax-saving benefits. However, they have several other features that an investor needs to understand in depth before investing in them. This type of fund provides an excellent avenue to grow your money while deriving tax exemptions under relevant tax laws.

This article discusses the meaning, benefits, and tax advantages of ELSS funds and provides a step-by-step guide for investing in them.

ELSS Funds Overview

Equity-Linked Savings Schemes (ELSS) are mutual funds that primarily invest in equities and equity-linked instruments. These funds feature a mandatory three-year lock-in period, making them the shortest among all tax-saving instruments.

ELSS is ideal for investors seeking tax savings under Section 80C of the Indian Income Tax Act while aiming for higher returns compared to traditional options like fixed deposits (FDs) or the Public Provident Fund (PPF).

How ELSS Funds Work

1. Equity Portfolio Investment

   ELSS funds invest a minimum of 80% of their corpus in equities and equity-related instruments and are, therefore, exposed to market risks and rewards.

2. Lock-In Period

   Investments in ELSS funds have a lock in period of three years, and therefore, you cannot redeem or withdraw your money before that period is over.

3. Tax-Saving Feature

   ELSS investments are eligible for tax deductions (which no other mutual fund offers) up to ₹1.5 lakh per year under Section 80C.

4. Returns

   Returns from ELSS funds depend on market performance. While they have better growth potential, they also have inherent market risks.

Advantages of ELSS Funds

ELSS funds have a unique combination of tax saving and investment benefits, which is the reason why this kind of fund is much favored by investors:

1. Tax Benefits

   Investment of up to ₹ 1.5 lakh made under ELSS qualifies for tax exemption under the Section 80C. The tax on dividends and capital gains, though applicable, would be at concessional rates.

2. Shortest Lock-In Period

   ELSS funds have a lock-in period of only three years, shorter than that of other tax-saving options like PPFs (15 years) or FDs (5 years).

3. High Returns Potential

   ELSS funds invest primarily in equities, which could provide substantial returns over the long term. Historically, ELSS funds have outperformed the traditional tax-saving instruments.

4. Systematic Investment Plan (SIP)

   You could invest in ELSS through SIPs, which makes it easier to save and invest smaller amounts periodically.

5. Diversification

   ELSS funds invest across sectors and market caps, thus offering diversification and reducing risk.

6. Professional Management

   The funds are managed by experienced professional fund managers who make informed decisions to avail greater returns.

How to Invest in ELSS Funds

Investing in ELSS funds is quite straightforward and could be done effortlessly online or offline:

1. Choose the Right Fund
   Research ELSS funds based on past performance, fund manager expertise, and expense ratio.
2. Complete the KYC Process
   Submit identity and address proof to update your KYC.
3. Decide the Investment Mode
   • Lump-Sum Investment: A one-time investment.
   • Systematic Investment Plan (SIP): Periodic investments of smaller amounts.
4. Select a Platform
   Invest via mutual fund houses, online platforms, or financial advisors.
5. Track Your Investment
   While ELSS has a lock-in period, periodically tracking fund performance helps evaluate future investment potential.

Tax Benefits of ELSS Mutual Funds

• Section 80C Deductions: Investments up to ₹1.5 lakh annually qualify for deductions under Section 80C.
• Capital Gains Taxation: Long-term capital gains (LTCG) above ₹1.25 lakh are taxed at 12.50%. Gains below ₹1.25 lakh are tax-exempt.
• Dividend Taxation: Dividends from ELSS funds are taxed as per the investor’s applicable tax rate.

Things To Keep In Mind Before Investing In ELSS Mutual Funds

1. Market Risk

   As ELSS funds invest in equities, they are prone to market volatility. Be sure you have the risk appetite for equity investments.

2. Lock-In Period

   Your investment will be locked in for three years. Before investing, consider your liquidity requirements in the investment.

3. Fund Performance

   Research the historical performance of the fund and compare it with your peers before investing.

4. Expense Ratio

   Check the fund’s expense ratio – as high expenses could reduce the overall returns.

5. Investment Horizon

   ELSS funds are best for long-term goals. A three-year lock-in is the minimum; consider staying invested longer for better returns.

6. Portfolio Diversification

   ELSS must be part of a well-diversified portfolio. Avoid allocating all your tax-saving investments to ELSS alone.

Conclusion

ELSS funds offer flexible investment options, tax savings, a potential for high returns, and a relatively short lock-in period. They are an excellent choice for investors looking to combine wealth creation with tax efficiency.

By aligning your financial goals, risk tolerance, and liquidity needs, ELSS funds can play a crucial role in achieving tax-saving and wealth-building objectives.

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