Did you hear you can save up to ₹46,800 per year by investing in ELSS funds? But what is an ELSS fund? How does it work?
Are they able to generate better returns than other tax-saving schemes? Let’s discuss this.
Estimated read time: 3 minutes and 49 seconds
Buckle up, here we go!
What is ELSS fund?
Equity Linked Savings Scheme (ELSS) is a type of mutual fund that invests primarily in equities and has a lock-in period of three years. ELSS funds were introduced in India in the late 1990s as a tax-saving investment option under Section 80C of the Income Tax Act.
Asset Management Companies (AMCs) manage ELSS funds. They are open-ended schemes, which means that you can invest in them anytime.
ELSS is the most popular tax-saving alternative under Section 80C, as it has a track record of producing better returns over the long run and the shortest lock-in period among all tax-saving instruments of three years.
It also carries a higher risk, as the value of your investment may fluctuate based on market conditions.
How do ELSS funds work?
Based on the rules, ELSS funds should invest at least 80% of their Asset Under Management (AUM) in equity. They can invest the rest in debt.
Most ELSS funds offered by different AMCs invest majorly in large-cap companies. And invest a small portion of their funds into mid and small-cap companies. So in simple terms, you can say they are similar to Multi-cap or Flexi-cap mutual funds.
Few funds also try to invest more in mid and small-cap companies to generate more returns. Remember, these funds have more risk than others.
How have the ELSS funds performed in the past?
Did you know, before 2022, SEBI never permitted AMCs to start a passive ELSS fund?
That’s why, as of now, all the ELSS Funds available in India are active funds. That means an expert manager actively manages the fund, so higher expense ratios and chances to generate alpha.
Just recently, IIFL launched India’s first passive ELSS fund, and we will have to wait a few years to see how it performs.
The returns generated by the active ELSS funds in India may vary depending on the fund’s investment strategy and the performance of the underlying assets.
Over the long term, ELSS funds have the potential to generate higher returns compared to other tax-saving options, such as fixed deposits or National Savings Certificate, because of their exposure to equities.
According to data from the Association of Mutual Funds in India (AMFI), the average annual returns generated by ELSS funds over various time periods are as follows (as of 28th December 2022):
- 3-year returns: 17.19%
- 5-year returns: 11.10%
- 10-year returns: 14.30%
You can check the data here. Remember, these are just average returns, and the actual returns that you may receive on your ELSS investment may be different.
The returns generated by ELSS funds in the past may not suggest future performance. You should also know that past performance is not a guarantee of future performance.
The 3-year lock-in period ensures that the investment is long-term and is protected from market fluctuations. And the 3-year lock-in period is just for your tax break. You can hold on to the ELSS fund as long as you want.
What are the tax benefits of ELSS investments?
As you might already know, you can claim a tax deduction of up to ₹1.5 lakhs on your ELSS investment in a financial year.
Also, since you won’t be able to redeem your investments for 3 years, the gains from your ELSS investments will be treated as long-term capital gains (LTCG). And they tax any gains over ₹1 lakh at 10%.
Some of you might think that you don’t have to pay tax on other instruments like PPF, NSC, etc at their maturity. But do you realise you are receiving a higher return even after paying the taxes in ELSS?
Yes, it comes with a risk. So it’s your choice.
Should you invest in ELSS to save tax under Section 80C?
ELSS funds have gained popularity in India over the years as a tax-saving option. Especially among investors who are willing to take on higher risk for the potential for higher returns.
However, as we always say, it is essential to consider your risk appetite and financial goals before making any investment decisions. You need to look at your overall financial portfolio.
To maximise your 80C deduction, first, buy good life insurance. If you are a salaried employee, you can add your employee provident fund claims. And then, you can decide whether to invest in ELSS or other tax-saving instruments to utilise the ₹1.5 lakh deduction completely.
If you already have invested in equity funds or individual stocks, look at your overall portfolio’s exposure towards equity.
If the exposure is high, you might invest in safer tax-saving instruments like PPF.
If your exposure is low, investing in ELSS funds can be a good starting point to invest in equity.
Need help finding the best ELSS fund? Read here.
Also, if you have invested in many mutual funds, you need to look at the overlap between the funds. Make sure the overlapping between the funds you invest in is low. You can check this overlap here.
Check out the investment scheme’s review series to learn more about the Public Provident Fund (PPF), Sukanya Samriddhi Yojana (SSY), and Post Office Schemes here.
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