ELSS Funds bring a dual benefit – probable wealth creation while saving tax! What’s more, they also help you aim for better returns when compared to other investment options. In spite of these benefits, many investors are unsure of investing in ELSS, due to the volatility and risk attached to it. Like many new investors, if you too have questions such as – is ELSS safe or how does ELSS work, or what are the best ELSS SIP plans, then this article is for you.
Before diving into the critical aspects of ELSS Funds, it’s imperative to understand what an ELSS Fund is.
A type of mutual fund, Equity Linked Savings Schemes or ELSS Funds, or Tax-saving Funds are one of the most popular investment instruments in India. Three key features distinguish ELSS Funds from other types of investments:
- Stock investment
A minimum of 80% of the money from ELSS Funds is invested in the stock market. That’s also a reason why ELSS Funds are considered to be volatile in nature.
- Lock-in period
ELSS Funds have a 3-years lock-in period. The ELSS lock in period is the lowest as compared to other investment instruments in the tax-saving category.
- Tax saving
Investments in ELSS Funds are eligible for tax benefits under Indian Income Tax Act’s Section 80C. No wonder it’s popularly referred to as the Tax-saving fund.
ELSS Funds are also well known for their potential to create wealth as they may fetch higher returns. And that’s why, although tax-saving is a crucial factor of ELSS investments, they are sometimes recognised as a pure-play equity product or a potential wealth creation investment option with a lock-in period instead of getting categorised as only a tax-saving product.
So How Does ELSS Work?
Investors can directly purchase units of ELSS Funds from the fund house’s website. Investors have another option to purchase units via an AMFI-certified mutual fund distributor or advisor. You can proceed with whatever method suits you, depending on your level of understanding and knowledge.
Further, ELSS Funds provide two options for investing – Growth and Income Distribution cum Capital Withdrawal (IDCW - earlier known as Dividend).
The growth option allows the investors to reinvest the profits in the same scheme, and at the time of redemption, the profits are distributed. Under the IDCW option profits may be distributed as IDCW, subject to available surplus. However, it is important to note that the declaration and payment of IDCW are not fixed and are completely dependent on profit generation. Apart from this, the effect on Net Asset Value (NAV) is also a critical factor for your investment decision.
Next, it is important to understand the two modes of investment in an ELSS Fund – lumpsum and SIP.
As the names suggest, a lumpsum investment is when you make a purchase of ELSS Funds according to your discretion, whereas SIP, also known as the Systematic Investment Plan, includes a regular investment. The SIP mode gives its investors the rupee cost average benefit. That is, investors keep buying units for a fixed amount at pre-decided time intervals irrespective of the market conditions. So, when the market is at a low, number of units purchased is high, and vice versa. Rupee cost averaging helps in balancing the market volatility to a great extent.
Here are some finer points that every investor must keep in mind when choosing ELSS Funds.
- In the case of SIP investments, the 3-year lock-in period will be different for every SIP. That is, investments made on 1st January 2023 will be available for redemption on or after 1st January 2026, whereas those made on 1st April 2023 will be available on or after 1st April 2026.
- The minimum investment amount for SIP is Rs. 500 while there is no limit on the maximum amount that you can invest.
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- While ELSS Fund investment helps with tax saving, the capital gain on these investments is taxable on exceeding certain amount as specified from time to time.
- Under Section 80C tax saving limit on investing in ELSS Funds is Rs.150,000. It’s important to note that this limit is the maximum after including other eligible investments, if any, that provide tax benefits, such as provident fund, life insurance, etc.
- Remember ELSS Funds may also help you to build wealth, not just save taxes.
But how to identify which ELSS Funds to invest in?
A few parameters that investors may consider before choosing an ELSS Fund for investment are:
- Consistent performance
When studying an ELSS Fund’s performance look for consistency. Especially focusing on periods of economic downturn. Avoid choosing a fund based on only recent performance. Look at the ELSS Fund’s performance over a period of time. - Fund diversification
Consider how diversified is the fund’s investment allocation. While there are different investment patterns, it is best to choose an ELSS Fund that aligns with your objectives. - Risk factor
Again, the investment style plays a critical role here. Because aggressive fund managers are bound to take more risks than conventional ones. The risk factor is reflected in the risk-o-meter of the scheme, which can be referred to in helping understand the overall risk category of the scheme. - Turnover ratio
The portfolio turnover ratio indicates how frequently a fund manager is buying and/or selling stocks in the fund, that is, entering and exiting the securities. A high turnover ratio suggests an aggressive investment pattern. - Expense ratio
A low expense ratio indicates that less amount is being spent on managing the fund. And thus, investors may fetch better returns from the scheme.
Equipped with all this information about ELSS Funds and how does ELSS work, start building your probable wealth creation journey, while enjoying tax benefits.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
Disclaimer: The information set out above is included for general information purposes only and does not constitute legal or tax advice. In view of the individual nature of the tax consequences, each investor is advised to consult his or her own tax consultant with respect to specific tax implications. Any action taken by you on the basis of the information contained herein is your responsibility alone. Tata Mutual Fund will not be liable in any manner for the consequences of such action taken by you. The information contained herein is not intended as an offer or solicitation for the purchase and sales of any schemes of Tata Mutual Fund.
