Why ELSS should be in your mutual fund portfolio?

What is an ELSS fund?

Equity Linked Savings Scheme (ELSS) is a category within mutual funds that primarily invests in equities and related instruments. This scheme offers the advantage of a tax-saving instrument under Section 80C of the Income Tax Act, 1961 while also providing the potential for substantial returns through equity exposure. ELSS funds generally come with a lock-in period of three years, setting them apart as an efficient avenue for tax-saving investments with a relatively shorter lock-in tenure.

• Table of contents

1. What is an ELSS fund?
2. Why ELSS should be in your mutual fund?
3. Who should consider investing in ELSS mutual funds?

What is an ELSS fund?

Equity Linked Savings Scheme (ELSS) is a category within mutual funds that primarily invests in equities and related instruments. This scheme offers the advantage of a tax-saving instrument under Section 80C of the Income Tax Act, 1961 while also providing the potential for substantial returns through equity exposure. ELSS funds generally come with a lock-in period of three years, setting them apart as an efficient avenue for tax-saving investments with a relatively shorter lock-in tenure.

Why ELSS should be in your mutual fund?

Consider the following factors before choosing an ELSS mutual fund.

Tax benefits

ELSS mutual fund is eligible for tax deduction under Section 80C of the Income Tax Act. An investor can claim a deduction of up to Rs. 1.5 lakh investment in ELSS funds.

ELSS funds have a lock-in period of 3 years and are treated as equity funds for taxation purposes. Therefore, on redemption, the profits from these schemes are categorized as long-term capital gains (LTCG). LTCG above the exempted annual limit of Rs. 1 lakh are taxed at a flat rate of 10% without indexation benefit. Additionally, dividends generated from ELSS funds are taxable in the hands of the investors at the applicable slab rate.

Potential for reasonable returns

With a focus on equities, ELSS has historically demonstrated the potential for higher returns compared to conventional tax-saving instruments such as PPF or NSC over extended periods. Thus, ELSS investments can help investors beat inflation over the long term thanks to the growth potential of equities. However, investors must note that ELSS investments returns are based on equity market performance and hence the market risk must be factored in which may not be the case with other fixed term investments.

Shorter lock-in period

ELSS boasts a relatively shorter lock-in duration of three years, providing investors with greater flexibility and liquidity compared to other tax-saving options like PPF or NSC.

Diverse portfolio

ELSS represents an equity-diversified mutual fund scheme consisting of diverse multi-cap stocks. This allows investors to access various companies and sectors, offering the flexibility to adjust the portfolio according to market conditions. A diversified portfolio mitigates risk by spreading investments across different sectors and market capitalizations, thereby enhancing the return potential.

Expert fund management

ELSS funds are managed by seasoned professionals who strategically invest in a diversified equity portfolio, leveraging their expertise to optimize the return potential for investors.

What are the factors to consider before investing in ELSS

Risk assessment

ELSS funds mainly focus on stocks and carry risks linked to the market. It's important to know your risk appetite before investing in ELSS funds.

Investment horizon

ELSS is ideal for investors with a longer investment horizon as they have the potential to generate substantial wealth over an extended period due to their exposure to equity markets.

Expense ratio

Always check the expense ratio of the fund you plan to invest in. Lower expenses indicate more efficient fund management, which could lead to potentially higher investor returns.

Who should consider investing in ELSS mutual funds?

• Salaried Individuals: If you're a salaried worker, you might already invest in fixed-income products like the Employees' Provident Fund (EPF). Choosing ELSS can help increase potential returns on your investments. ELSS not only offers a good return potential over the long term but also qualifies for tax deductions under Section 80C. Comparatively, other options like ULIPs and the National Pension System (NPS) have longer lock-in periods and potentially lower returns. ULIPs are locked for five years, while NPS is designed for retirement and locked until you're 60 years old. ELSS, in contrast, has a shorter lock-in period of just three years.
• First-time Investors: If you're new to investing, ELSS can serve as a great starting point. It provides tax benefits and introduces you to equity investing and mutual funds. While equity investments carry short-term risks due to market volatility, these risks diminish significantly if you invest for the long term. Starting with monthly investments (SIPs) in an ELSS fund allows you to leverage rupee-cost averaging and accumulate more scheme units when the market is down. This averages out the cost of investment and enhances the return potential over the long horizon.

Conclusion

ELSS can serve as a crucial component of any mutual fund portfolio, offering a blend of tax-saving advantages and potential wealth creation through equity exposure over the long term. Its shorter lock-in period, potential for higher returns, and professional management make it an appealing option for tax-efficient investments and long-term wealth building. However, investors should conduct thorough assessments of their risk tolerance, investment goals, fund performance, and other factors before incorporating ELSS into their mutual fund portfolios.

Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.