Equity Linked Savings Schemes (ELSS) are one of the most popular tax-saving investment options in India. As the name suggests, ELSS funds are mutual funds that primarily invest in the stock market, and they come with the added benefit of tax deductions under Section 80C of the Income Tax Act. If you are wondering, “What are ELSS funds?” and how they can benefit you, this article is here to help. We’ll walk you through the basics, how they work, their benefits, risks, and answer some frequently asked questions (FAQs).
What Are ELSS Funds?
To understand what ELSS funds are, let’s break it down:
- Equity: These funds invest in stocks or equity markets, meaning your money is invested in shares of various companies across different sectors.
- Linked Savings: These funds are linked to tax savings, which means they qualify for tax deductions under Section 80C.
- Scheme: It is a type of mutual fund, offering an option for investors to pool their money together in the stock market.
In simpler terms, ELSS funds are equity mutual funds that allow you to save taxes while investing in stocks. They come with a lock-in period of three years, which is the shortest among all tax-saving options under Section 80C.
How Do ELSS Funds Work?
When you invest in an ELSS fund, your money is pooled with that of other investors and managed by professional fund managers. These funds primarily invest in the stock market, buying shares of companies in the form of equity instruments. The fund manager’s job is to make informed decisions on where to invest, aiming for long-term capital appreciation.
The performance of the ELSS fund depends on the performance of the stocks it holds. If the companies in the fund’s portfolio perform well, the value of the fund increases, and you can earn capital gains.
Features of ELSS Funds
1. Tax Benefits:
The biggest advantage of investing in ELSS funds is the tax benefit. You can claim a deduction of up to ₹1.5 lakh per year under Section 80C of the Income Tax Act. This helps in reducing your taxable income, lowering your tax burden.
2. Short Lock-in Period:
ELSS funds come with a mandatory lock-in period of 3 years. This is the shortest among other tax-saving instruments like Public Provident Fund (PPF), National Savings Certificates (NSC), and Tax-saving Fixed Deposits, which have longer lock-in periods.
3. Potential for High Returns:
Since ELSS funds invest in equities, they offer the potential for higher returns than traditional tax-saving instruments. However, higher returns come with higher risk, as the stock market can be volatile in the short term.
4. SIP Option:
You can invest in ELSS funds through a Systematic Investment Plan (SIP). This allows you to invest small amounts regularly (monthly or quarterly) rather than making a lump sum investment. SIP helps in averaging the cost of buying units of the fund and mitigating market volatility.
5. Diversification:
ELSS funds offer diversification by investing in multiple stocks across sectors and market caps. This reduces the risk of loss associated with investing in individual stocks.
Types of ELSS Funds
ELSS funds come in different categories based on their investment strategies. Some of the common types include:
Large-Cap ELSS Funds
These funds invest in well-established, stable companies with a large market capitalization. They are considered safer but may offer lower returns compared to other types of funds.
Mid-Cap ELSS Funds
These funds invest in medium-sized companies that have the potential for growth. These funds are riskier but can provide higher returns.
Small-Cap ELSS Funds
These funds invest in smaller companies that have the potential for high growth. However, they carry higher risk and volatility.
Multi-Cap ELSS Funds
These funds invest across different market caps—large, mid, and small. They provide a balanced risk-reward ratio by diversifying investments across sectors and companies of different sizes.
Benefits of ELSS Funds
Now that we know what ELSS funds are and how they work, let’s discuss some of the key benefits:
1. Tax Savings Under Section 80C:
Investing in ELSS funds allows you to reduce your taxable income by up to ₹1.5 lakh per year. This is a significant tax benefit for individuals who are looking for ways to save on taxes.
2. High Return Potential:
Since ELSS funds invest in equities, they provide the opportunity for high returns compared to other tax-saving instruments. Over a long-term horizon, equity investments typically have the potential to deliver superior returns, although they are subject to market fluctuations.
3. Liquidity:
ELSS funds have a lock-in period of just 3 years, which is relatively shorter compared to other tax-saving instruments. This means you can access your funds sooner in case of emergencies, although it’s advisable to remain invested for a longer period to maximize returns.
4. Professional Fund Management:
ELSS funds are managed by experienced professionals who have the expertise to make investment decisions on your behalf. You don’t need to worry about tracking the stock market or selecting individual stocks.
5. Flexibility:
You have the flexibility to invest in ELSS funds either through a lump sum or through SIPs. This makes them accessible for both small and large investors.
Risks of ELSS Funds
While ELSS funds come with numerous benefits, they also have their share of risks. Being equity-based, these funds are exposed to market fluctuations and economic cycles. Some of the risks associated with ELSS funds include:
- Market Risk: Since ELSS funds invest in the stock market, they are subject to market volatility. If the stock market declines, the value of the fund may also decrease.
- No Guaranteed Returns: Unlike fixed-income investments like PPF, ELSS funds do not offer guaranteed returns. The returns depend on the performance of the underlying stocks.
- Liquidity Risk: While the lock-in period is relatively short (3 years), you still cannot redeem your investment before the completion of the lock-in period, which may be a disadvantage if you need immediate access to funds.
How to Invest in ELSS Funds?
You can invest in ELSS funds in the following ways:
- Through a Lump Sum Investment:
If you have a lump sum amount to invest, you can buy units of an ELSS fund directly from an Asset Management Company (AMC) or through online platforms. - Through SIP (Systematic Investment Plan):
If you prefer to invest in small amounts regularly, you can opt for an SIP. You can choose the amount, frequency, and duration of your SIP, making it a flexible investment option for individuals with varying investment capacities. - Through Mutual Fund Distributors:
You can also invest in ELSS funds through mutual fund distributors who will guide you through the process and offer personalized advice based on your financial goals.
Choosing the Right ELSS Fund
When selecting an ELSS fund, consider the following factors:
- Past Performance: While past performance is not a guarantee of future returns, it can give you an idea of how the fund has performed over time.
- Fund Manager Expertise: Check the track record and experience of the fund manager. A good fund manager can make a significant difference in the performance of the fund.
- Expense Ratio: This is the fee charged by the fund to manage your investment. A lower expense ratio means more of your money stays invested in the fund.
- Risk Profile: Different ELSS funds have varying risk profiles. Choose a fund that aligns with your risk tolerance and investment horizon.
Conclusion
In conclusion, ELSS funds are an excellent investment option for Indian investors looking to save taxes while also benefiting from the growth potential of the stock market. They offer a combination of tax-saving benefits, potential for high returns, and professional management, making them a popular choice among investors.
FAQs about ELSS Funds
What are ELSS funds?
ELSS (Equity Linked Savings Scheme) funds are a type of mutual fund that primarily invests in equities. They offer tax-saving benefits under Section 80C of the Income Tax Act and come with a lock-in period of 3 years.
How do ELSS funds work?
ELSS funds pool money from various investors and invest it in stocks. The performance of the fund depends on the performance of the underlying stocks, and the returns are subject to market conditions.
What are the tax benefits of ELSS funds?
ELSS funds offer tax deductions of up to ₹1.5 lakh under Section 80C of the Income Tax Act. The returns from the fund are also subject to long-term capital gains tax (LTCG) of 10% if the holding period exceeds 3 years.
What is the lock-in period for ELSS funds?
The lock-in period for ELSS funds is 3 years, which means you cannot redeem your investment before that period.
Are ELSS funds safe?
ELSS funds are subject to market risk because they invest in equities. While they have the potential for higher returns, they also carry the risk of losses due to market fluctuations.
Can I invest in ELSS funds via SIP?
Yes, you can invest in ELSS funds through a Systematic Investment Plan (SIP), where you invest a fixed amount on a regular basis, helping you average the cost of purchasing units.
What is the difference between ELSS and other tax-saving options?
ELSS funds are riskier but offer higher potential returns compared to other tax-saving options like PPF or National Savings Certificates (NSC), which are low-risk but offer fixed returns.
How do I choose the best ELSS fund?
When choosing an ELSS fund, consider the fund’s past performance, expense ratio, risk profile, and the experience of the fund manager. It’s also essential to align the fund with your financial goals.