Equity Linked Saving Scheme (ELSS)
Equity Linked Saving Scheme (ELSS)
As the name suggests, Equity Linked Saving Scheme or ELSS is a type of mutual fund scheme that primarily invests in the stock market or Equity. Investments of up to 1.5 Lac done in ELSS Mutual Funds are eligible for tax deduction under section 80C of the Income Tax Act. The advantage ELSS has over other tax Saving instruments is the shortest lock-in period of 3 years. This means you can sell your investment only after 3 years, from the date of purchase! However to maximise returns from ELSS funds, it is recommended to keep your investments intact for the maximum duration possible. If you have an ELSS SIP (Systematic Investment Plan), each instalment has a lock-in period of three years, which means each of your instalments will have a different maturity date.
1. How ELSS Mutual Funds Work?
ELSS Funds are diversified equity funds. These funds primarily invest in stocks of listed companies in a specific proportion according to the investment objective of the fund. The stocks are chosen from across market capitalisation (Large Caps, Mid Caps, Small Caps) and industry sectors. These funds aim to maximise capital appreciation over the long run. The fund manager picks stocks after conducting an in-depth market research to deliver optimal risk-adjusted portfolio returns.
2. ELSS Tax Benefits
Investments made in an ELSS fund are eligible for tax benefits under Section 80C of the Income Tax Act, 1961. While there is no upper limit to the amount that can be invested, a maximum of Rs. 1.5 lakh is eligible for a tax deduction as per the Income Tax rules and save up to ₹46,800 a year as tax amount.
3. Who Should Invest in ELSS Mutual Funds
- Salaried Individuals: When you are a salaried employee, there is a amount that goes towards Employee Provident Fund (EPF) which is a fixed income product. If one wants to balance out risk & return on their investment portfolio then ELSS is the best option. In addition to the upside of extraordinary returns, investments in ELSS are also eligible for tax deduction under section 80C. While Unit Linked Insurance Plans (ULIPs) and the National Pension Scheme (NPS) also do the same, they have a higher lock-in period & lesser potential of returns. For instance, ULIPs have a lock-in period of five years. NPS is more of a retirement solution with partial exposure to equity and the invested amount is locked till the age of 60 years. With an ELSS fund, you have the shortest lock-in period of only three years.
- First time investors: If you are a new investor, ELSS is an ideal choice, since in addition to tax benefits you get a flavour of equity investing and mutual funds. Yes, equity investments do carry a higher risk, but that is generally over the short term. If you invest for more than five years, the risk is much lower. Like all equity investments, the best way is to start investing in monthly SIPs through the year. SIP in a ELSS fund helps you to accumulate more units when the market is in red and generate exceptional returns when the markets are favourable. Read our blog on Why ELSS should be your first Mutual fund? to understand the benefits in detail.
4. Things To Consider Before Investing in ELSS Funds
- “ Fund returns: Before you go for a fund, compare the fund performance with its competitors & benchmark to know if it has shown consistent performance in the past. If a fund outperforms its benchmark or competitors, then the fund delivers high returns.
- History of fund house: It is recommended to choose fund houses that have performed consistently over a long period, say about five to 10 years.
- Expense ratio: The expense ratio depicts how much of your investment goes towards managing the fund. If a fund has a lower expense ratio, it means you can have higher take-home returns – so it’s always better to go for such funds.
- Financial parameters: You can also consider several parameters such as Standard Deviation, Sharpe Ratio, Alpha and Beta to analyse the performance of a fund. A fund with a higher standard deviation and beta is more risky than one with a lower deviation and beta. Choose funds with a higher Sharpe ratio.
- Fund manager: The fund manager is another factor to consider, because he / she is the person who plays a key role in management of your funds. The fund manager must be competent and must have great experience in picking the right stocks and creating a strong portfolio.
5. Top Performing ELSS Funds
It is sometimes a tedious task to choose a fund – the right way is to analyse and compare different parameters of various funds before choosing one. That’s not all – investing in a fund is dependent on an individual’s financial goals, investment horizon, and risk appetite.
6. Advantages of ELSS Mutual Funds
Here’s a look at the advantages of ELSS Mutual Funds:
- Shortest lock-in: ELSS has the shortest lock-in period of three years. Tax-saving fixed deposits have a five-year lock-in, while PPF has a 15-year maturity. All in all, ELSS offers more liquidity in the medium term.
- Potentially higher returns: Unlike ELSS where return is market linked, other 80C investments like PPF or FDs are fixed income products. ELSS has the potential to generate significantly higher wealth in a medium to long-term investment horizon.
- Better post-tax returns: Long Term Capital Gains from ELSS are tax free up to limit of ₹1 lac. Gains over 1 lac attracts a tax rate of just 10%. Lower tax rates, coupled with higher returns ensure the best post tax returns.
- Regular investing is hassle-free and convenient: It is easy to invest in ELSS funds through a monthly SIP.
7. Tax Implications on ELSS
Capital gains from ELSS get the same treatment in Income Tax Calculation as rest of the Equity Instruments. Short term capital gains (STCG) attract a tax of 15%, while Long Term Capital gains (LTCG) are only taxable if the gains exceed ₹1 lac during the financial year. LTCG attracts a tax of 10% on the amount exceeding ₹1 lac. Read ETMONEY’s blog on How Mutual Fund Investments are taxed to understand the taxation in detail.
8. Ways to Invest in ELSS Funds
- Growth option: When you go for the growth option, you will not receive benefits in the form of dividends. As an investor, you will get the gains only at the time of redemption – this helps to appreciate the total NAV and thus, the profits multiply. There’s one thing to keep in mind – the returns are subject to market risk.
- Dividend option: Under this option, an investor gets benefits from time to time in the form of dividends, which are completely tax-free. The dividend is declared only when there are excessive profits, over and above.
- Dividend Reinvestments option: This is an option under which an investor reinvests the dividends received to add to the NAV. This works well, particularly when the market is witnessing an upswing and is likely to continue the same way.
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