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ELSS funds – What is it & How to invest in ELSS Mutual Funds?

  • Rudri Rawell
  • Feb 03 2022
  • 8 minutes
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Investors who invest in equity are often cautious about the risk involved and the chances of losing money in such investments. Smart investors, however, aim to save money and have a long-term perspective while investing in equities. One of the ways in which equity investors save money is by investing in ELSS or Equity Linked Savings Schemes. 

Equity-linked saving scheme (ELSS) is often preferred by investors who want to save tax. It is a type of mutual fund scheme that primarily focuses on investments in equity or equity-related instruments. In the past few years, ELSS funds have become a preferred tax-saving investment option for many investors. 

Here, we will explore some of the important aspects of ELSS funds and highlight ways in which these investments can help investors in saving tax.

What are ELSS Mutual Funds?

ELSS mutual funds have an asset allocation strategy that focuses primarily on equities. The portfolio of these schemes comprises 65% equity and equity-linked securities ( For ex-listed shares) and the remaining is allocated to fixed-income securities in some cases. These funds generally have a lock-in period of three years. Through investment in ELSS mutual funds, investors can get a dual benefit of tax deductions combined with wealth creation over time.

What are the important features of ELSS funds?

Some of the important features of ELSS are:

  • ELSS portfolio mostly comprises equities and limited exposure to fixed-income securities
  • ELSS investment can offer dual benefits of tax deductions and wealth creation
  • ELSS funds are a tax-saving investment option that also has the potential to offer inflation-beating returns
  • ELSS funds have a lock-in period of three years, and most funds do not allow investors to make an early exit. Even during a downturn in the market, investors cannot redeem their investment in ELSS. This prevents any panic-related outflows and helps to increase the chances of capital appreciation.
  • There is no upper limit on the amount that can be invested in ELSS. The minimum investable amount could vary across fund houses.
  • Through ELSS investment, investors can avail tax deductions of up to Rs 1,50,000 a year as per the provisions of Section 80C of the Income Tax Act
  • With SIP investment in ELSS mutual funds, investors can ensure a disciplined investment and benefit from the rupee cost averaging that can nullify stock market volatility to an extent.
  • ELSS mutual funds can generate better returns as compared to investments such as NSC, PPF, VPF, etc. However, since ELSS investments are market-linked, there is no guarantee of returns.

What is the tax treatment of ELSS investments?

Investors must learn about the tax treatment of ELSS investments before making an investment decision. Here are some of the important points to note:

  • Capital gains from ELSS have the same tax treatment as gains from any Equity Instruments. 
  • Short term capital gains (STCG) attract a tax of 15%
  • Long Term Capital gains (LTCG) are taxable if the gains exceed Rs. 1 lakh during a financial year. 
  • LTCG is taxed at 10% on the amount exceeding Rs. 1 lakh (the limit of 1lakh is inclusive of all equity investments) 
  • From the FY 2020-21, dividends received by investors are taxable at 10% when in excess of Rs 5000 from any mutual fund.

ELSS Funds Compared to Other Tax-Saving Options:

For Investors who are considering long-term tax-saving investments, here is a comparison between ELSS and other tax-saving instruments:

  ELSS NSC PPF
Lock-in Period 3 Years 6 Years 15 Years
Min. Investment Rs. 500 Rs. 100 Rs. 500
Max. Investment No Limit No limit Rs. 1,50,000
Returns Dividends/ Returns linked to Market (Average of 15% over the past 5 years) Compounded Half-Yearly, Currently 8% Compounded Annually, 8%
Exemption Under Section 80C Rs. 1,50,000 Rs. 1,50,000 Rs. 1,50,000
Tax on Interest Not applicable Taxable Tax-free
Risk Index Medium to High Risk Medium (partial exposure to equity) Low Risk

Who should invest in ELSS Mutual Funds

ELSS mutual funds see a wide variety of investors from salaried individuals to new investors and even seasoned investors who are looking to diversify their portfolio. Here are some details on the same:

Salaried Individuals

For salaried employees, contribution to Employees Provident Fund (EPF) becomes a part of yearly investment towards a fixed income product. For those looking to balance out the risk & returns in their portfolio, ELSS investment can be a good option.

Apart from the possibility of higher returns, investments in ELSS also provide the benefit of tax deduction under section 80C. Although Unit Linked Insurance Plans (ULIPs) and the National Pension Scheme (NPS) also provide similar benefits, the setback is a higher lock-in period & lower scope of returns.

ULIPs come with a lock-in period of five years, and NPS is considered an investment option for retirement since the invested amount is locked until the investor turns 60 years of age. Among all these, ELSS investment comes with the shortest lock-in period of three years.

New Investors

For new investors who want to gain experience of equity investing through mutual funds along with tax benefits, ELSS can prove to be an ideal choice. Although equity investments come with substantial risk, it is generally in short term due to market fluctuations. If one remains invested for more than five years, the risk can be relatively lesser. New investors can begin ELSS exposure through monthly SIPs spread across the year. ELSS investment through SIP can help in accumulating more units when the market performance is in a downswing and may generate better returns as the market performance turns favourable. 

ELSS can come across as an excellent way of building wealth for a young investor as he/she can take some risks as the time is their side.

How to invest in ELSS Funds?

To invest in ELSS funds, investors can easily download and install the Finity app and follow the below steps:

  1. Navigate to the ELSS mutual funds section on the app and go through the list of available options
  2. Study the historical returns of the available options and select an option to invest
  3. Click on Invest against the ELSS fund name
  4. Select SIP or lump-sum option and enter the amount to be invested
  5. Continue towards payment
  6. Enter the bank and personal details to complete the investment process.

How to redeem ELSS Units?

In ELSS, every SIP instalment has to complete the mandatory 3-year lock-in period. Thus, if an investor invests in ELSS via SIP, after completion of 36 months he/she can only redeem the units allotted through the first SIP instalment. Subsequent units can be redeemed when they complete the three year lock-in period.

Although investors can redeem their proportion units after completion of three-year lock-in period, it is not mandatory to do so. Once the lock-in period ends, the fund turns into a diversified, open-ended equity-oriented scheme. Therefore, investors can choose to redeem the units as per their requirement.

It is important to note that the lock-in period is applicable on the date of purchase of the fund units or the SIP date. Let’s understand this with the help of an example:

SIP Date Units Last Date of Lock-In Period 
01 April 2021 100 01 April 2024
01 May 2021 95 01 May 2024
01 Jun 2021 99 01 Jun 2024
01 Jul 2021 110 01 Jul 2024

As per the above example, SIP units purchased on 1st April 2021 can be redeemed after 1st April 2024. Similarly, units purchased on 1st July 2021 can only be redeemed after 1st July 2024.

Conclusion

Investors can sell their investment in ELSS only after completion of the 3-year lock-in period. However, for those looking to maximise returns from ELSS investment, it is ideal to remain invested for a longer duration. 

FAQs on ELSS funds

  1. Is ELSS good for investment?
    ELSS is a preferred investment considering its tax benefits combined with a potential to fetch higher returns. Apart from this, investors also invest in ELSS because of a relatively shorter lock-in period of 3 years. Tax exemption can be availed on Long-Term Capital Gains from ELSS up to a maximum of Rs. 1 lakh.
  1. What are the benefits of ELSS ?
    Some of the key benefits offered by ELSS investments are:
  • ELSS has the shortest lock-in period of three years.
  • ELSS returns are market-linked and investors can therefore have a scope of making better returns as compared to other products within 80C investments such as PPF or FDs that are fixed-income products.
  • Investors can generate better post-tax returns.
  • Investing in ELSS is easy and can also be done online.
  1. When should I invest in ELSS?
    Investors who want to invest in ELSS for tax-saving purposes must make the investment at the start of the financial year. This will help in planning out finances and calculating tax obligations well in advance.
  1. Is ELSS better than PPF?
    As per Section 80C of the Income Tax Act, investment in ELSS of up to Rs. 1,50,000 in a financial year is tax deductible. PPF investment too is tax-deductible up to a maximum of Rs. 1,50,0000. However, PPF may offer lower returns in the long term as compared to ELSS. ELSS investments do not guarantee returns, and there is also the risk of equity exposure in these. PPF works well for risk-averse investors or investors approaching their retirement/goal soon.
  1. Can I redeem ELSS after 3 years?
    Yes, you can redeem your ELSS investments after 3 years if you need the funds. Or there is no harm in continuing with the investment for any period of time you wish.
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