Why Should Investing In ELSS Funds Be A Habit?

What is an ELSS Fund?

An Equity Linked Saving Scheme (ELSS) fund is a type of mutual fund eligible for tax deductions as part of the Income Tax Act, 1961. You can avail a tax rebate and save immensely each year by investing in ELSS mutual funds.

A majority of the funds' asset allocation is usually made towards equity and equity-linked securities like shares and could feature some exposure to fixed-income securities too. Furthermore, ELSS funds have the shortest lock-in period of 3 years out of all investments under Section 80C.

Tax benefits of ELSS

ELSS investments are one of the most popular forms of tax planning as they offer tax deductions of up to INR 1.5 Lakhs per annum under Section 80C of the Income Tax Act. They may also earn notably higher returns compared to other tax-saver instruments as returns are linked to the stock market's performance.

Additionally, if you are a part of the highest tax slab and make full use of Section 80C's provisions, then you will be able to save nearly INR 46,800 a year via ELSS mutual funds. The 3-year lock-in period can also be beneficial as it allows you to reap your returns much sooner than most other mutual funds' investments. However, no provisions for making a premature exit exist under it.

The gains earned on ELSS also qualify for Long Term Capital Gains, meaning they are tax-free up to INR 1 Lakh, but will incur 1% tax on amounts over this.

Features of ELSS Funds

• There are no limits on the amount that can be invested in ELSS. However, the minimum investment amount can vary from one fund house to another.
• These are the only kind of tax saving instruments that have the potential to provide you with inflation-beating returns.
• Investing in ELSS can give you the dual benefit of wealth creation and tax savings.
• Multiple ELSS funds can help diversify your investments throughout industries and sectors.
• You can also choose from a wide range of stocks based on their market capitalisation and future growth prospects to receive the best returns.
• While these funds do not guarantee you returns due to their dependence on the stock market, they are relatively high-risk investments. However, the returns could be quite high.
• When it comes to returns, ELSS offers you growth and dividend options. In the growth option, your income will grow over time to gain better returns, while the dividend route will ensure you earn regular income over the 3-year lock-in period.
• You can either renew your ELSS funds or sell it after the lock-in period.

Who can be eligible for investing in ELSS funds?

While there is no specific age restriction placed on making investments in ELSS, it is ideal for investors who do not necessarily have high incomes and therefore have lesser risk appetite and tolerance.

Professionals who have just started working can also begin their investment journey by putting their resources into such schemes. It is also suitable for those looking to diversify their investment portfolio, and they can invest in about 3-4 top ELSS funds to boost it further.

Things to consider before investing in ELSS funds

While going for ELSS mutual funds, it is crucial for you to keep in mind certain factors that may influence your decisions as well as the fund's long-term performance. These are:

1. Tax Planning: If tax savings is your primary concern for investments, then opting for other options could suit you better. These include investments in schemes like Provident Fund (PF) or National Pension Scheme (NPS), also eligible for tax savings under Section 80C.
2. Liquidity: It is important to consider your expenses in the long run, as ELSS funds have a lock-in period of three years, with no provision to exit prematurely from it.
3. Lump sum or SIP: Many professionals that make investments in ELSS funds for tax benefits do so as a lump sum at the last minute. This option may not be feasible for you as it could be financially challenging. Opting for SIPs could be a better alternative as they average the costs of each unit.

Advantages of ELSS

• The minimum 3-year lock-in period of ELSS can make it an attractive proposition for many.
• Returns earned under it are significantly better than most other competitive products.
• Transparency is ensured as the portfolio it is being invested in is visible to all investors involved.
• On the completion of the lock-in period, you can claim 100% of it.
• You have the flexibility of choosing between a lump sum and SIP form of investing.
• Fund managers can help manage your ELSS funds, which makes the process much simpler and easier.

Disadvantages of ELSS

• Non-guaranteed returns due to it being market-linked could make investing in ELSS funds a riskier option.
• The gains earned after the 3-year lock-in period are liable to taxation as per the Long-Term Capital Gains (LTCG) on amounts over INR 1 Lakh.
• It is not ideal if you are a conservative investor, as exposure towards equity cannot be avoided.

Opting for ELSS Funds may seem like an attractive investment opportunity, as it could provide you returns on your investments and offer tax-saving benefits as an add-on. However, prioritising your financial goals before going for the right scheme will be critical but fruitful if well strategised.