A Dummy’s Guide to Elss Tax Saving Mutual Funds

It is a common tendency among us to procrastinate about making tax-saving investments until the last moment in the financial year. As a result, we tend to go for the wrong decisions more often.

The key here is to have a serious concern to begin investing right from the start of the financial year. We need to shift the notion of tax-saving into tax planning, and that requires us to create strategies to maximize tax savings along with wealth creation.

If you are aiming to save taxes, you have a variety of options to choose from, that qualify for deductions under Section 80C of the Income Tax Act, 1961. But, how do you opt for the one that’s right for you? There couldn’t possibly be one answer to that.

That’s because everyone’s needs are different, and so are their goals and risk appetite. However, it’s essential to understand that investments are not meant for just saving taxes, but also to create wealth and beat inflation over the long term.

ELSS mutual funds can be your best option as they provide both tax-saving benefits as well as a scope for higher growth potential over time.

The following post answers most of the questions that new investors usually have regarding ELSS. Let’s begin.

What is ELSS?

The Equity Linked Savings Scheme, also commonly called as ELSS fund, is an excellent way of saving tax and gaining potential returns. Owing to its diversified and open-ended nature, investors can enter the fund whenever they want and can have any number of shares. ELSS funds operate legally under Section 80C of the Indian Income Tax Act. It can help you to save taxes up to Rs 1.5 lakh and grow your money simultaneously.

The fund can be usually locked in for three years and is mostly invested in the stock market. Another significant benefit of investing in ELSS funds is that no tax will be levied on the long-term gains received from the investment.

The investment in an ELSS scheme can either be made in a lump-sum or through a Systematic Investment Plan (SIP).  Till the financial year 2017-18, the income from long-term capital has not been liable for tax deduction from an assessee when they redeem their unit of an ELSS. According to the Budget (Finance Act) passed in 2018, the government can levy taxes at 10% of the capital gain if it is more than Rs. 1 lakh.

Categories of ELSS

ELSS funds fall into two major categories – the dividend scheme and the growth scheme.

In the case of the dividend scheme, income to each unitholder comes in the form of a dividend based on the units that they hold. They can withdraw their dividends or reinvest them. The earned dividend is also eligible for tax benefits.

As the earned dividends do not have a lock-in period, the unitholder gets the freedom to withdraw the dividend at any time.

Growth schemes don’t offer such benefits.

What are the features of ELSS Mutual Funds?

  • To be eligible for tax deduction benefits, an assessee starts investing in an ELSS mutual fund with an amount as low as Rs. 500. While there is no maximum limit to the amount that one can invest in ELSS, unlike NSC and PPF, you are applicable for a tax exemption of up to Rs. 1.5 lakh.
  • The investment in an ELSS scheme is usually made for a long duration as it has a lock-in period of three years. Despite such short time duration, ELSS funds have always been capable of yielding substantially higher returns as compared to other alternatives like PPF and ULIP.
  • The primary portfolio underlying ELSS funds consists of investments made in company equities with sound business models. As it is equity-based, it is prone to be affected by market risks.
  • ELSS are open-ended funds that can issue an unlimited number of shares. The fund sponsors can issue and redeem shares at any time.
  • Much like other mutual funds, ELSS funds also have the option where the investor can choose another person as his/her nominee.
  • Investors are charged a percentage of the fee on the purchase of ELSS funds called as entry load. If they wish to exit or redeem their investment before the lock-in period is over, they have to pay the exit load.

How can investing in an ELSS help you?

The following points describe a few of the benefits that you can get by investing in ELSS funds.

  • As mentioned earlier, investing in an ELSS funds makes you eligible for a maximum tax deduction of Rs. 1.5 lakh.
  • While eliminating systematic risks completely in mutual fund investments doesn’t seem to be possible, the fund manager can surely remove unsystematic risks by investing the funds in diversified equities.
  • Sometimes, the investor may not want to redeem the investment even after the end of 3 years lock-in period. In such a case, the investment grows and subsequently brings substantial inflation risk-adjusted return to the investor.
  • As they are free of restrictions, the investor can withdraw any dividend earned before the lock-in period is over.
  • Owing to the open-ended nature of ELSS mutual funds, investors have the option to make investments at any time of the year.
  • There are other popular tax saving avenues as well, such as NPS, ULIP, and PPF, which have a lock-in period ranging from six to fifteen years. ELSS funds offer a clear advantage to investors looking for a shorter lock-in period.
  • As investor funds are managed by a qualified fund manager, investors don’t have to worry if they lack the knowledge of the market.
  • The scope of ELSS funds goes beyond just delivering tax benefits. It can also prove quite useful as a long-term wealth generation tool. Investing in ELSS can help to meet any future financial goal.

Investing in ELSS? When is the right time to do it?

While there are no restrictions regarding the time to make investments in ELSS, it’s better to make it at the start of the financial year – 1st April. People tend to search for means of reducing their tax liability during the filing season. This is the time when most ELSS investments can be seen.

Doing this at the end of the financial year will help them save taxes, but they won’t have any chance of receiving any capital growth or dividends for that year.

Since ELSS invests primarily in equities, investing in them every month through SIP to average out the Rupee-cost is a good idea. With SIP, investors will get the most out of their investments by earning the highest returns along with being a tax-saving investment.

How to choose the right ELSS fund?

If you are looking to invest in an ELSS fund, consider the following key points:

  • Dive into the history: There is no way in which you can judge the future performance of a mutual fund scheme based on its past performance. The sole purpose of looking at its history should be to evaluate the scheme as the first step.
  • Age of an ELSS fund: Generally, new investors are advised to go for a fund that has existed in the market for at least five years. It is considered ideal because such funds usually have good track records and represent reputed AMCs.
  • Risks involved with ELSS: Each ELSS scheme is different and bears different risks. Therefore, investors should choose a particular ELSS fund that is in accordance with their risk appetites.
  • Being aware of the Expense Ratio: Asset Management Companies charge a percentage of the funds from the unitholders commonly referred to as the expense ratio. It helps them to manage the costs associated with the operations of the fund.
  • Assets Under Management (AUM): AUM refers to the measure of the total amount of money and financial assets managed by the mutual fund scheme on behalf of its clients.
  • Review their Ratings: Investors can go through the ratings of an ELSS fund published in a reputed online platform to make decisions about which fund to choose.

Final words on ELSS Mutual Funds

The equity market has been witnessing a steep rise over the years, leading to the increasing popularity of ELSS mutual funds among the investors. ELSS mutual fund is a variety of equity mutual fund which was created by the government to work as an effective income saving instrument as well as influence the public to take an interest in the equity market of India.

The tax deduction is probably the most crucial benefit that ELSS funds offer, thus attracting the attention of the middle-aged population and encouraging them to invest their savings in the Indian equity market.

However, it’s crucial to note that the benefits of investing in ELSS scheme do not come without risk.  Frequent ups and downs happening with the NAV graph of the scheme, but that doesn’t make the growth of the fund go down below other tax-saving alternatives like ULIP and PPF.

Since Equity Linked Saving Schemes carry the immense possibility of bringing higher returns with a small lock-in period, they have come to emerge as the in-demand tax saving option today.

Author Bio: Ankur Choudhary

Ankur founded Goalwise a direct mutual fund investment appin 2015 to serve as a ‘Fitbit to investing’. They pioneered an investing approach making it easier for users to set, track, and achieve their long and short term financial goals. A passionate Algo-investor, he honed his skills as a Researcher and Portfolio Manager at leading hedge funds such as WorldQuant and Oxus investments. He is an alumnus of IIT Kanpur where he pursued Computer Science and Engineering.