What are ELSS Mutual Funds

21 May, 2024

Synopsis

• ELSS is a tax-saving investment tool that helps reduce tax liabilities and offers potential returns for future financial objectives.

• Features of ELSS funds include a lock-in period of 3 years, tax deduction of up to ₹1.5 lakh under section 80C, and the ability to deliver inflation-beating returns.

• Ideal for investors with a high-risk tolerance and a long-term investment horizon, ELSS funds provide a short lock-in period, exposure to equity markets, and investment flexibility through lump sum or SIPs.
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To live comfortably while working, one needs a robust support system. To create such a support system, one needs to save and invest in building a corpus over time that can cover future expenses. To have surplus funds for investing, one could use a tool to reduce one's tax liability.

The question is: Does such a system exist in reality? One that can help you save taxes and invest and generate returns to help you achieve your dreams? Well, it does. ELSS, or Equity-Linked Savings Scheme, is the 'Support System’ you seek. It's like a double bonanza – ELSS helps you save taxes and grow your money.

What is ELSS?

An Equity-Linked Savings Scheme (ELSS) is an equity mutual fund eligible for tax deductions of up to ₹1.5 lakh under section 80C. ELSS mutual funds have a compulsory lock-in period of 3 years, which is the key parameter for the tax break. With ELSS funds, investors can get low-cost exposure to equity markets while saving tax.

Features of ELSS Funds

Here are some of the key features of ELSS mutual funds:

• Investments in diversified equities across market capitalisation and sectors.

• Have a lock-in period of 3 years.

• Offer tax deduction under section 80C up to ₹1.5 lakh.

• Have the potential to deliver inflation-beating returns in the long run.

• Allow lumpsum investment or periodic investment via SIPs.

• Carry high risk as most of the portfolio is invested in equities.
  
  

How Do ELSS Funds Work?

ELSS funds work just like other diversified equity mutual fund schemes. The only differences are the 3-year lock-in period and tax benefit eligibility under Section 80C.

Here’s a quick overview of ELSS mutual funds:

• The fund manager invests across a range of stocks after research.

• A minimum of 80% of the portfolio is invested in equities.

• The remaining portion could be invested in debt and money market instruments.

• The investor gets units based on investment amount and prevailing NAV.

• Units can be redeemed after 3 years at the applicable NAV.

• Long-term capital gains above ₹1 lakh are taxed at 10%.
  
  

Who Should Invest in ELSS?

ELSS funds are suitable for investors with a high-risk appetite and the ability to remain invested for at least 5 years or longer. They are a good investment option for:

• Investors in the higher tax brackets looking for tax-saving options.

• First-time equity investors.

• Long-term investors wanting to build a retirement corpus.

• Salaried and self-employed individuals.

• Investors wanting to diversify beyond traditional tax-saving options.
  
  

What are the Benefits of Investing in ELSS funds?

Here are some of the major benefits of investing in ELSS mutual funds:

Short Lock-in Period

The 3-year lock-in in ELSS mutual funds makes it more appealing than other tax-saving instruments with a longer lock-in period of 5-15 years. The short lock-in allows for better liquidity.

Equity Exposure for Higher Returns

By investing predominantly in equities, ELSS funds have the potential to deliver inflation-beating returns over long periods. This is higher than traditional tax-saving options.

Tax Savings under Section 80C

The tax deduction of up to ₹1.5 lakh under section 80C helps reduce your income tax liability. This tax benefit comes with the upside of equity exposure and wealth creation.

Professional Fund Management

ELSS funds benefit from professional equity research and fund management, which ensures your money is invested prudently for optimal risk-adjusted returns.

Flexibility of Investment

You can make lump sum investments in ELSS funds or through SIPs that allow periodic investments.

Low-Cost Route for Equity Exposure

Compared to investing in equity stocks directly, ELSS offers a well-diversified equity portfolio at very low costs due to economies of scale.

Long-Term Wealth Creation

ELSS funds have the potential to deliver high inflation-adjusted returns over long periods of 5 years or more, making them a good route for wealth creation.

Things To Consider Before Investing in ELSS

While ELSS funds make a good investment, here are a few things to keep in mind:

• Analyse past returns across market cycles and fund managers' track records.

• Assess your risk tolerance, as most of the ELSS portfolio will be in equities.

• Avoid investing purely for tax saving objectives - ensure it aligns with long-term investment objectives.

• Choose funds from reputed AMCs with established track records and performance.

• Evaluate other metrics like portfolio composition, expense ratio, assets under management, etc.

• Consider investing through SIPs to get benefit from rupee cost averaging.

ELSS funds allow investors to save taxes through section 80C deductions while participating in the equity markets. The short lock-in period, wealth creation opportunity and tax efficiency make ELSS a preferred tax-saving option for many savvy investors. However, asset allocation suitability per risk profile and returns expectations should drive the investment decision.

Download the HDFC Bank SmartWealth App to invest in tax-saving ELSS funds.

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