ELSS is a Mutual Fund that allows individuals to claim income tax deductions covering up to Rs. 1.5 lakhs per year under Section 80C of the Income Tax Act, 1961. However, investing more than Rs. 1.5 lakhs do not qualify for tax benefits. Traditional tax-saving instruments typically offer fixed returns, which do not consider the high inflation in an economy like India. ELSS mutual funds invest in equities, generating higher inflation-adjusted returns over a longer timeframe. Investing in ELSS for the long term helps set off short-term volatility associated with equities. The funds are managed by professionals, ensuring no market timing concerns. Most of the portfolio comprises equity and equity-linked securities, with some exposure to fixed-income securities. ELSS funds have a lock-in period of three years only, making them the shortest among all Section 80C investments.
Features of ELSS funds
Here are the primary characteristics of ELSS mutual funds:
- Under Section 80C, it provides tax deductions of up to Rs 1,50,000 annually.
- It offers a lock-in period of 3 years, and no early exit options are available.
- It allocates at least 80% of its funds to stock investments like equities.
- The minimum investable amount differs throughout fund houses, but you can invest any amount in ELSS as there is no upper cap.
- ELSS tax saving is the only one that can yield returns that beat inflation.
- It provides you with returns that are linked to the market, and its performance is based on the performance of the portfolio's underlying equities.
- Investment in ELSS funds provides dual benefits of wealth creation and tax deduction.
- ELSS funds often reduce the concentration risk by investing in various stocks from different industries.
- An ELSS fund's portfolio comprises equities, but it also includes some exposure to fixed-income securities.
Tax advantages of ELSS mutual funds
- Investments in ELSS are eligible for a tax deduction under Section 80C of the Income Tax Act. By investing in ELSS funds, you can get a tax deduction of up to Rs 1.5 lakh, saving you up to Rs 46,800.
- Since ELSS funds have a lock-in period of 3 years, you cannot redeem to the three-year lock-in period. You will, therefore, be required to pay 10% long-term capital gains tax when you redeem your ELSS funds. However, there is no tax if the gain is less than Rs 1 lakh.
Functioning of ELSS mutual funds
The ELSS funds are basically equity funds that are diversified. Most of these funds' investments are made in the equities of publicly traded corporations or listed companies. The selection of equities considers all market capitalizations (big, medium, and small caps) and financial sectors. The long-term goal of these funds is to achieve the greatest possible capital appreciation. The fund manager performs extensive market research before selecting stocks to achieve the optimal possible risk-adjusted portfolio returns. Under Section 80C of the Income Tax Act of 1961, investments made in an ELSS fund are eligible to participate in tax benefits. A tax deduction can be claimed for investments up to a maximum of Rs. 1.5 lakh, even though there is no upper limit to the amount that can be invested. One can reduce their annual tax liability by as much as ₹46,800 if they invest this amount in an ELSS.
For whom are ELSS mutual funds a good investment?
Salaried people: ELSS Mutual Funds are suitable for salaried individuals who contribute towards the Employees' Provident Fund (EPF), a fixed-income product. They offer significantly higher returns over the long term and are eligible for tax deduction under Section 80C. Unlike unit-linked insurance plans (ULIPs) and the National Pension System (NPS), ELSS has a shorter lock-in period of only three years.
New investors: For first-time investors, ELSS offers a blend of equity investing and mutual funds, with higher risk over the short term due to volatility. However, the risk is much lower if invested over five years. The best way to invest in an ELSS is through monthly SIPs, which help accumulate more units during market downturns and generate good returns during favorable markets. ELSS funds also provide tax benefits, making them an ideal choice for those looking to diversify their investment portfolio.
Things to be considered Before Investing in ELSS Funds
Investing returns: Before investing in a fund, it is important to evaluate its performance compared to that of the other funds and the standard of comparison to determine if it has regularly outperformed them in the past. Although no fund can be consistently at the top of the rankings, good funds tend to remain in the top quartiles for extended periods.
Overview of the fund house's history: It is advisable to select fund companies that have established a track record of sustained success over a considerable amount of time, say between five and ten years.
Managing the fund: The fund manager plays a significant part in managing your funds. When selecting the appropriate stocks and putting together a robust portfolio, he or she must be knowledgeable and experienced.
Ratio of expenses: The expense ratio is a measure that reflects the proportion of your investment that is allocated to the operational management of the fund. You will have higher returns if you invest in a fund with a reduced expense ratio; therefore, investing in funds with such metrics is always preferable.
Determinants of the finances: To evaluate the performance of a fund, you may also take into consideration several criteria, including the standard deviation, the Sharpe ratio, alpha, and beta. Compared to a fund with a lower standard deviation and beta, one with a larger standard deviation and beta is considered riskier.
Investing in SIP: Before investing in ELSS, consider whether to invest in a SIP or lump sum strategy. The SIP method allows regular, monthly investments, while the lump sum strategy involves a significant amount in a single payment. The SIP method offers cost averaging, allowing higher units during market downturns and cheaper ones during upturns. However, if you have extra cash, investing in a single lump sum may be more suitable. The SIP mode is generally considered the best option due to its cost-averaging benefits.
