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What are ELSS Funds?

What are ELSS Funds?

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Equity Linked Savings Scheme (ELSS) are also referred to as tax-saving mutual funds in India. Under section 80C of the Income Tax Act, they provide both wealth-creation opportunities and tax-saving benefits. These funds have a lock-in period of three years which is the shortest among all the tax-saving investment options available in India. ELSS funds are a popular choice of investment for long-term investors because they offer high returns. In this blog, we will explore what are ELSS funds, how they work, their benefits, risks and a lot more. 

How Do ELSS Mutual Funds Work?

Now that you have understood what are ELSS funds, let’s understand how they work. ELSS funds are diversified equity funds.  They mostly invest in stocks of listed companies and then the stocks are selected from across the market capitalisation and sectors. These funds aim for capital appreciation over the long term. ELSS funds have a mandatory lock-in period of three years which means they cannot be withdrawn or redeemed before the period is completed. Only after three years they can be either redeemed or stay invested to continue benefiting from the market growth.

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Table of Content

  1. How Do ELSS Mutual Funds Work?
  2. Who Should Invest in ELSS Mutual Funds?
  3. Things to Consider Before Investing in ELSS Funds
  4. What are the Benefits and Risks of Investing in ELSS Funds

Who Should Invest in ELSS Mutual Funds?

The following individuals can invest in ELSS mutual funds
 

  • Salaried Individuals: Salaried individuals contribute towards the Employees’ Provident Fund (EPF), which is a fixed-income product. If an individual wants high returns then ELSS funds can be a suitable investment option. While unit-linked insurance plans (ULIPs) and the National Pension System (NPS) also do the same, they have a higher lock-in period and lesser potential for returns. For instance, ULIPs have a lock-in period of five years. 
  • First-time investors: ELSS can be a great option if you are a new investor as they provide tax benefits. They have comparatively lower risk than direct stocks. The best way to invest in these funds is through SIPs. 
  • Taxpayers: If you are a young taxpayer then you can invest in these funds. They save tax under section 80C of the Income Tax Act. Other taxpayers can also take advantage of this.
  • Long-Term Investors: As the lock-in period of ELSS funds is three years, it is suitable for long-term investors. The lock-in period applies to SIP payments as well.  So if an individual wants to withdraw the full amount invested over 12 months, they will have to wait till the last SIP instalment has been completed. 

Things to Consider Before Investing in ELSS Funds

Along with learning what is an ELSS  mutual funds, it is essential to keep some factors in mind while investing in them. The following are the things that need to be considered before investing in ELSS funds.  

  • Fund Performance: Before you start investing in a fund, you should research and compare its performance with other competitors. 
  • Expense Ratio: The expense ratio shows how much you invest in managing the funds. Select the funds which have lower expense ratios for higher net returns.
  • Financial Reports: You can check the financial reports of the ELSS funds to examine their historical performance and asset allocation. This will help you in making more informed decisions. 
  • SIP or Lumpsum: The two main types of methods through which you can invest are either SIP or lumpsum. Under the SIP method, you can invest a regular amount monthly. However, under the lumpsum method, you invest a huge sum of funds at once. 
  • Fund manager: The fund manager will assume an important function in managing your funds. Thus, he/she should be efficient and have enough experience to pick the right stocks and create a suitable portfolio.

What are the Benefits and Risks of Investing in ELSS Funds

The following are the benefits and risks of investing in ELSS funds.

Benefits 

Risks

ELSS investment is tax-deductible under the Income Tax Act. In this, one is eligible to claim a deduction of up to ₹1.5 lakh annually under Section 80C of the Income Tax Act for investment in an ELSS fund.Since the tax benefit is capped at ₹1.5 lakh, this limits how much one can invest and avail himself of a deduction.
The lock-in period of ELSS is relatively less than other tax-saving instruments.The fund has a lock-in period of 3 years and does not permit withdrawal before that period is over.
ELSS is essentially an equity fund and, therefore, more likely to be able to yield better returns than the traditional tax-saving instruments.Equity investments are subject to market risks, and returns can be volatile, especially in the short term.
ELSS allows for SIP (Systematic Investment Plan) investments, enabling disciplined investments.SIPs in ELSS  have the same 3-year lock-in period for each installment and this reduces the volatility. 
Long-term capital gains on ELSS up to ₹1 lakh are tax-free. This is, therefore, a tax-efficient investment avenue as well.LTCG above ₹1 lakh in a financial year attracts tax at 10%, thus reducing the returns overall.
ELSS funds are managed by professional fund managers, making it suitable for investors lacking financial expertise.The performance of funds would depend on the skill and strategy of the fund manager. However, not all funds have a fair performance.

Conclusion
ELSS mutual funds provide a balanced investment opportunity by combining tax-saving benefits with potential long-term capital growth. Understanding what are ELSS funds is important for investors who want to optimise their investment strategy while saving on taxes. Despite the risks associated with equity investments, ELSS can be a reasonable choice for those with a longer investment horizon and a higher risk tolerance. To start your journey with ELSS and explore different fund options, consider using an online trading app that provides easy access and insights into various mutual funds.

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FAQs on What are ELSS Funds

Yes, you can invest more than ₹1.5 lakh, but the tax deduction under Section 80C is limited to ₹1.5 lakh per financial year.

Yes, investing in ELSS through SIP can be an appropriate option. It helps in averaging the cost of investment and offers flexibility in managing funds.

ELSS investments cannot be redeemed before the completion of the 3-year lock-in period.

Yes, returns above ₹1 lakh are subject to Long-Term Capital Gains (LTCG) tax at 10%.

Investors seeking short-term gains should not invest in ELSS funds as one cannot obtain any returns before the 3-year lock-in period ends. Moreover, you may have to pay some penalty for withdrawing funds during this period.