Equity Linked Savings Scheme or ELSS mutual funds are a great investment option for those who are looking for wealth generation, getting regular returns and saving taxes at the same time. These are excellent tax-saving investment options that you can opt for generating profits in the long run.
To learn more about ELSS mutual funds and their various aspects, read the article below.
What is an ELSS Mutual Fund?
Equity-Linked Saving Scheme (ELSS), commonly referred to as the tax-saving funds, fall under the diversified category of mutual funds. While their maximum exposure is towards equity and equity-oriented securities, a part of the corpus is also invested in debt instruments.
ELSS is covered under the Section 80C provisions and therefore, you can claim tax deductions of up to Rs 1,50,000 a year. This will help you save up to Rs 46,800 a year in taxes. These funds come with a mandatory lock-in period of three years, which is the shortest among all 80C options.
Features of ELSS Mutual Funds
Here are some of the most important features of ELSS mutual funds:
- These mutual fund schemes diversify their investments by purchasing equities across different sectors, themes and market caps.
- At least 80% of the fund’s capital investments consist of equity and equity-related instruments. The remaining amount goes into hybrid and debt funds.
- They do not have a maximum tenure of investment
- The income that these schemes generate is treated as long-term capital gains (LTCG) and thus taxed accordingly
- Tax relief on the invested capital is mentioned under Section 80C of the Income Tax Act
Who Should Invest in Best ELSS Mutual Funds?
Any individual or HUF looking to save up to Rs 46,800 a year on taxes can consider investing in ELSS. However, these funds are suitable only for those who are willing to take some risk and can stay invested for at least the mandatory lock-in period of three years should invest in ELSS.
Investors are advised to stay invested for a minimum of five years to reap the best returns offered by mutual funds. Five years is a reasonable time. You will give your investments the much needed time to go through the market cycles and provide excellent returns in the long run.
Young investors in the initial years of their professional career can invest with a long-term horizon. ELSS is best suited for young investors as they have time on their side to unleash the power of compounding to the fullest and enjoy high returns while saving on taxes of up to Rs 46,800 a year.
How to Evaluate the Best ELSS Mutual Funds
- Fund Returns
Compare the fund’s performance with peers to ensure that the fund has been consistent over the past years. Based on these parameters, you can invest in the recommended funds. However, remember that the past performance is not indicative of future returns. The future returns are dependent entirely on the market movements and fund manager’s decisions.
- Fund History
Choose fund houses that have performed consistently over a long period, say 5 years to 10 years. A fund’s performance is reflected based on the quality of stocks in its portfolio and benchmark.
- Expense Ratio
Expense ratio depicts how much of your investment goes towards managing the fund. A lower expense ratio translates into higher take-home returns. Therefore, if there are two funds with a similar track record and asset allocation, you need to choose that fund which has a lower expense ratio.
- Financial Ratios
Consider various parameters such as Standard Deviation, Sharpe ratio, Sortino ratio, Alpha, and Beta to analyse the performance of a fund. A fund with a higher standard deviation and beta is riskier than a fund having a lower deviation and beta. Choose funds with a higher Sharpe Ratio as they offer higher returns for the additional risk you take. The fund manager plays a crucial role.
Use ClearTax ELSS Calculator to calculate your invest returns.
Advantages of Investing in ELSS Funds
- Dual benefit of tax rebate and wealth growth
ELSS is the only investment option that not only provides tax deductions under the provisions of Section 80C of the Income Tax Act, 1961 but also helps in wealth growth. The equity exposure of the ELSS funds gives you an opportunity to earn excellent returns on staying invested for at least five years.
- Shortest lock-in period among Section 80C options
ELSS mutual funds come with a lock-in period of just three years, which happens to be the shortest among all tax-saving investment options under Section 80C of the Income Tax Act, 1961. Therefore, ELSS mutual funds are more liquid as compared to any other Section 80C investment.
- Potential to earn inflation-beating returns
ELSS mutual funds are the only Section 80C investment option which has the potential to offer inflation-beating returns. This is what makes ELSS to stand out among all tax-saving investment options.
- Expert money management
All mutual funds are handled by finance professionals called ‘fund managers’. These are individuals with an excellent track record of managing portfolios, and hold various certifications in the field of finance. Every fund manager is backed by a team of market researchers and analysts, who pick only the best-performing securities, which will benefit investors in the long run.
- Option to invest monthly
You can start investing in the top ELSS funds using SIP of as low as Rs 1000. Moreover, there’s no upper limit on amount of investment.
How can you save Rs 46,800 in tax through ELSS?
ELSS is an excellent tax saving instrument for people who fall in the higher income tax brackets. You can save up to Rs 46,800 if you invest Rs 1.5 lakh per annum in ELSS and are in the 30% income tax bracket.
However, you get a maximum tax deduction of Rs 1.5 lakh per year in ELSS under Section 80C even if you invest more than this amount.
Table showing how much you save in tax if you fall in the higher income tax slabs:
Maximum amount that can be invested under Section 80C for ELSS | Rs 1,50,000 | |
Income Tax Rate | 30% | 20% |
Income Taxes Saved | 45,000 (Rs 150000 * 0.3) | 30,000 (Rs 150000 * 0.2) |
Health and Education cess @4% | 1,800 (Rs 45,000 * 0.04) | 1,200 (Rs 30,000 * 0.04) |
Total Taxes Saved | Rs 46,800 | Rs 31,200 |
You can save Rs 31,200 a year in taxes if you invest Rs 1.5 lakh per year in ELSS and fall in the 20% income tax bracket. Moreover, you can save Rs 46,800 a year in taxes if you invest Rs 1.5 lakh per year in ELSS and fall in the 30% income tax bracket.
Comparison with other Tax Saving Investments
There are several other savings schemes that helps in wealth creation like FD, PPF and NSC to name a few. But the returns from these schemes are taxable. This is where ELSS (Tax Saving Mutual Funds) stands out with its dual-benefit – its returns are generally higher and tax-free. This coupled with a mere lock-in period of 3 years is all the more reason for you to invest in ELSS ( Tax Saving Mutual Funds ) now. Here is a quick glimpse at how ELSS is superior to other commonly used tax-saving investments:
| Investment | Returns | Lock-in Period | Tax on Returns |
| 5-Year Bank Fixed Deposit | 6% to 7% | 5 years | Yes |
| Public Provident Fund (PPF) | 7% to 8% | 15 years | No |
| National Savings Certificate (NSC) | 7% to 8% | 5 years | Yes |
| National Pension System (NPS) | 8% to 10% | Till Retirement | Partially Taxable |
| ELSS Funds | 15% to 18% | 3 years | Partially Taxable |
Things Investors Should Consider Before Investing in ELSS Funds
The following are the critical factors that must be considered by investors before they invest in ELSS mutual funds:
- Lock-in period
Like any other tax-saving investment option, even ELSS mutual funds come with a lock-in period. It is for three years for ELSS, and it is mandatory. There are no provisions to make premature withdrawals. Therefore, investors must be willing to stay for at least three years from the date of purchase of units.
- Risk factor
Since ELSS mutual funds are equity-oriented, they are naturally influenced by the market movements. Furthermore, these funds carry all the risks that an equity fund possesses. Therefore, investors must be willing to assume these risks by investing in ELSS mutual funds. Assessing your risk profile is a must.
- SIP and lump sum
All mutual funds allow you to invest in two ways; lump sum or systematic investment plan (SIP). Most investors prefer taking the SIP route since they can stagger their investment over a period. You can invest a small sum on a regular basis via an SIP. Investing through an SIP is advisable since it provides the benefit of rupee cost averaging in the long run. A lump-sum investment is generally not advisable unless there is a significant chance of making overwhelming gains.
Taxability of ELSS Mutual Funds
Since ELSS mutual funds are a class of equity funds, they are necessarily taxed like an equity fund. Any dividends offered by these funds are added to your income and taxed as per the income tax slab you fall under. Until Budget 2020, dividends were made tax-free in the hands of investors as the fund house was supposed to pay dividend distribution tax.
Since there is a mandatory lock-in period of three years, there is no question of enjoying short-term capital gains. Therefore, the tax on short-term capital gains on selling the fund units of ELSS mutual funds is non-existent. The long-term capital gains of up to Rs 1 lakh a year are made tax-exempt. Any long-term gains exceeding Rs 1 lakh are taxed at a rate of 10%, and there is no benefit of indexation provided.
Risks Associated With ELSS Funds
Since ELSS mutual funds are equity-oriented funds, they carry the same levels and kinds of risks that any other equity mutual fund carries. However, these risks can be mitigated to a great extent by staying invested for a minimum of five years. Also, the mandatory lock-in period of three years helps significantly in reducing the risk.
Bottom line:
ELSS is suitable for investors with higher risk tolerance as it invests its assets predominantly in equity and equity-related securities. ELSS is an excellent investment for those in the higher income tax brackets.ELSS has the shortest lock-in period among Section 80C investments. Investing in ELSS helps you create wealth and save taxes.
Frequently Asked Questions
You may invest in regular plans of ELSS through a mutual fund distributor. You can invest in the direct plan of the ELSS mutual fund online directly with an AMC. You must create an account with the AMC. Fill up the application form with personal details such as name, mobile name and so on.
You may complete your eKYC by submitting your PAN and Aadhaar details. You may give online instructions to your bank to transfer the requisite amount to the fund house on a specified date and start investing in the ELSS mutual fund.
You may invest in ELSS mutual funds online through online platforms such as cleartax invest.
- Log on to cleartax invest.
- You must pick the mutual fund house from the list of fund houses
- Select the ELSS mutual fund scheme based on your investment objectives and risk tolerance and click on Invest now
- Select the amount you plan to invest in the ELSS mutual fund scheme and the mode as either One Time or Monthly SIP.
You may submit the cheque for the initial amount and you are allotted a PIN and folio number. You can also approach a mutual fund distributor and invest in the regular plan of the mutual fund.
You may invest in a direct plan of a mutual fund online through an AMC. You must fill up the registration form and complete your eKYC by submitting PAN and Aadhaar details. You may also invest in an online portal such as cleartax invest.
- You must first complete your KYC before investing in a mutual fund. You may do so at a KRA (KYC Registration Agency) online by filling the KYC registration form and submitting the self-attested identity and address proof.
- You then visit the website of the fund house and choose the mutual fund scheme of your choice.
- You may fill an application form with required details such as name, mobile number, PAN and create a username and password.
- You then enter your bank account details and set up the SIP auto-debit amount.
- You may log on to your account created at the fund house and choose the mutual fund scheme.
- You must make the first SIP instalment online and the next instalment after 30 days. (The AMC will intimate you on the requisite date).
- You may continue the SIP till the end of the chosen tenure. (You may decide the tenure of the SIP).
You could invest a lump sum amount in mutual funds through an online platform such as cleartax invest. You just have to log on to cleartax invest and select the mutual fund house and the scheme. You then select the amount and the mode of investment as One Time if you want to put a lump sum amount in a mutual fund.
- You may fill up your STP form and submit it at the office of the AMC. You could fill this form online at the website of the mutual fund house.
- Select the mutual fund scheme (destination fund) where you intend to invest for the long-term.
- You may then select the mutual fund scheme (source fund) where you want to invest the lump sum amount.
- You may choose the time-frame from where the lump sum amount invested may be moved to the destination fund. You can choose daily, weekly or monthly STPs according to your convenience.
You can invest in mutual funds in the name of a minor child. The minor child is the sole holder in the mutual fund folio. The guardian for the mutual fund folio must be a parent or a court-appointed guardian.
- You may approach the branch of an AMC.
- Submit documents showing the child’s date of birth such as passport or birth certificate while opening a mutual fund folio. You also need documents to establish the relationship between the minor child and the parent/guardian. (For parent it could be the passport and for the guardian it is the copy of the court order)
- The parent/guardian must be KYC-compliant to invest in mutual funds in the name of minor child
- You can even register an SIP or STP instruction in the mutual fund folio of a minor child. However, it would cease once the minor child turns 18 years of age.
However, you may invest in regular plans of debt funds through a mutual fund distributor. You can invest in debt funds through an online platform such as cleartax invest.
However, you may consider investing in gold funds or Gold ETFs through the SIP route. You may invest just Rs 500 per instalment. You can invest in Gold ETFs and gold funds through online platforms such as cleartax invest.
You may invest in direct plans of equity funds and ELSS through an asset management company. However, you could consider investing through a broker for regular plans of these mutual funds.You could invest in equity funds and ELSS through online platforms such as cleartax invest.
You may invest in International Mutual Funds directly through an AMC in India. It is an Indian mutual fund scheme which invests in stocks of foreign companies. However, you may consider the fund of funds schemes which invest in foreign mutual funds or whose portfolio mimics a stock market index such as the Nasdaq 100 or S&P 500.
You can invest in International Mutual Funds through an online platform such as cleartax invest.
- Log on to cleartax invest
- You must opt for the mutual fund house from the list of fund houses
- Select the International Mutual Fund under the category ‘Equity’ based on your investment objectives and risk tolerance and click on Invest now
- Select the amount you plan to invest in the mutual fund and the mode as One Time or SIP.
However, you must complete your KYC by submitting a self-attested identity and address proof and passport size photographs at the branch of the mutual fund house. You may complete eKYC online by submitting your PAN and Aadhaar details before investing in mutual funds.