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What is ELSS Mutual Fund and How Does It Work?

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It’s necessary for anyone seeking to secure their financial future to embrace investment planning. There are many investment schemes in the market to choose from but most of them are subject to taxes based on the Income Tax rules. If you are an investor who is looking for a potent mix of wealth creation and tax saving, the ELSS mutual fund stands out as a great option. ELSS mutual funds provide tax deductions up to Rs. 1.5 lakh under Section 80C of the Income Tax Act while potentially providing some big returns.

In this guide, we’ll take a closer look at ELSS mutual funds, explore what they are, how they work, and the benefits they bring to the table. We’ll also see how one can start investing in ELSS mutual funds. Let’s go!

What is ELSS Mutual Fund

ELSS, or Equity Linked Savings Scheme, is a type of mutual fund that puts a significant part of its corpus into stocks or stock-related instruments. As the name suggests, ELSS funds are focused on equity and come with a compulsory lock-in period of three years. They seamlessly combine the potential for wealth appreciation with the added advantage of tax savings. Due to that it is also sometimes called a tax saving scheme. Because of this dual advantage, investors have been flocking to ELSS funds in recent years. Now that you know the ELSS mutual fund meaning, it’s time to understand how they work.

How ELSS Mutual Funds Work?

ELSS mutual funds primarily invest in equity markets, meaning as an investor it provides you with an opportunity to participate in the growth potential of stocks. ELSS funds have a lock-in period, typically three years and this lock-in period makes sure that investors commit to staying invested for three years and align with the fund’s goal of promoting wealth creation over the long-term.

ELSS funds leverage the power of diversified equity investments to generate returns and are known for their varied portfolios. The fund manager carefully and strategically allocates assets across various stocks based on market research, where they evaluate the market conditions, risk levels, economic trends, and the fund’s investment objectives. Their main focus is on investing in stocks of publicly traded companies with different market capitalizations – large caps, mid caps, and small caps. By investing in ELSS mutual funds you get to benefit from professional management and get exposure to a diversified portfolio without having to actively manage individual stocks.

Features of ELSS Mutual Funds

Here are some of the features of ELSS mutual funds:

  • These funds seek to maximise long-term capital appreciation. This objective is promoted by the compulsory lock-in period of three years, which is the shortest lock-in period among all tax-saving investment options.
  • The vast majority of the total corpus is invested in equity or equity-related instruments, comprising more than 80% of the overall investment.
  • One can stay invested for as long as they want after the three year lock-in period as there is no maximum tenure of investment in ELSS.
  • ELSS funds offer investors a tax deduction under Section 80C of the Income Tax Act which makes them an attractive option for people looking to minimise their tax liabilities.
  • By investing in equity markets, ELSS funds provide the potential for high returns which makes them suitable for investors with a higher risk tolerance. You’ll likely get better returns by investing in ELSS than you will get by investing in more traditional options, such as the Public Provident Fund. 
  • Because this fund has a diversified portfolio across different market capitalisations, it provides a layer of protection against the impact of poor performance in any single area and reduces the associated risk.
  • These mutual fund schemes are open-ended, which means one gets the flexibility to redeem their units at any time once the lock-in period of three years is completed. Thus, ELSS funds provide liquidity.
  • One can start investing in ELSS funds with a large lump sum, but they also allow investors to enter the market through SIPs, which is what most people prefer as it provides a disciplined approach to investing in small amounts. 
  • One does not have to start investing in ELSS with large amounts, some funds even allow investors to start investing with an amount as low as Rs. 500.

Also Read: Factors to Consider Before Investing in ELSS Mutual Funds

How to invest in ELSS Funds?

Investing in ELSS funds is a pretty straightforward process and you can invest in them just like you would in any other mutual fund. Here’s a step-by-step guide to help you get started:

  1. Conduct thorough research and select a fund that is suited to you. The fund should align with your financial goals and risk tolerance. Try exploring different ELSS funds and consider factors like past performance, the expertise of the fund manager, and the fund’s investment philosophy.
  2. Choose your platform for investment. There are many mutual fund investment platforms you can pick from online or you can invest through your demat account or an agent. 
  3. Now complete the KYC, that is the Know Your Customer process with your mutual fund platform. Make sure all your details and documents such as address proof, identity proof, aadhar card, PAN card, and bank details are in order.
  4. Now choose the mode of investment. Decide your investment amount and whether you want to invest through a lump sum amount or opt for a Systematic Investment Plan. Most people pick the SIP route as it is easier to stay disciplined. You can start investing for an amount as low as Rs. 500.
  5. You will now have to fill out an application form for the ELSS fund you’ve picked. Provide all the details accurately as required.
  6. It’s time to submit the application form along with the necessary documents and make the payment online or through bank transfer. 
  7. You’re done! Now you have to diligently keep track of your investments and periodically review your portfolio. Again, remember that there is a three-year lock-in period. After three years, you’ll have the option to cash out or you can continue your investment for as long as you would like.

What are the tax benefits offered by ELSS Mutual Funds?

What makes ELSS funds one of the stand-out choices out of the many investment options is the dual benefit they provide – potentially high returns and a range of tax benefits. Let’s take a closer look at some of the benefits:

Investments you make in ELSS funds are eligible for a deduction of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act, and you can save up to Rs 46,800 a year in taxes. This can help you optimise your tax liability. 

Out of other investment options that provide tax benefits such as Public Provident Fund and Unit Linked Insurance Plans, the lock-in period of ELSS funds is the shortest at three years. For ULIPs, one has to wait five years before redeeming, and PPF has a lock-in period of fifteen years.

Due to the three year lock-in period, one cannot realise short-term profit gains.

Gains made through ELSS funds up to Rs. 1 lakh are exempt from taxation.

If your gains exceed Rs. 1 lakh, they will be subject to a 10% long-term capital gains tax.

As you can see there are many tax benefits that ELSS provides but to make the most informed decisions regarding your ELSS investments and overall tax planning, you should consider consulting with a qualified tax advisor. The tax landscape is always changing and an experienced tax advisor can provide personalised guidance based on your income and goals.

Conclusion:

A good ELSS fund can offer high returns between 10% to 12% but beyond the potential for high returns, ELSS funds provide a gateway to tax optimisation, and this dual benefit is the reason why it’s one of the most popular options available to investors. Because the ELSS fund is a type of mutual fund that invests in equities, it carries a certain level of risk so before you invest, it’s very important on your part to consider your risk appetite. Remember there is a lock-in period of three years and the returns are not guaranteed, so it’s wise to consult an investment planner. An experienced investment planner can help you select the best ELSS fund that aligns with your risk level and financial goals.