ELSS Funds Meaning, Benefits, Eligibility, Features And How to apply

How ELSS Mutual Funds Works

ELSS funds function as diversified equity funds, predominantly investing in stocks of listed companies. This investment approach spans market capitalisation categories, including large, mid, and small caps, as well as various sectors. The primary objective of ELSS funds is to achieve maximum capital appreciation over the long term. Fund managers meticulously select stocks through in-depth market research to yield optimal risk-adjusted portfolio returns.

Investments in ELSS funds qualify for tax benefits under Section 80C of the Income Tax Act, 1961. While there is no upper limit on the investment amount, a maximum of Rs. 1.5 lakh is eligible for tax deduction under the IT Act. Investing this amount in ELSS can result in annual tax savings of up to ₹46,800.

ELSS Mutual Funds Tax Benefits

• According to Income Tax rules, investments in ELSS are eligible for a deduction under Section 80C, allowing a deduction of up to Rs 1.5 lakh. This can lead to tax savings of up to Rs 46,800.
• Due to the 3-year lock-in period, premature redemption of ELSS funds is not permitted. If redeemed before three years, long-term capital gains tax at 10% is applicable. However, gains within the limit of Rs 1 lakh are exempt from tax.

ELSS Funds: Who All Should Invest

Salaried Individuals: For salaried employees contributing to the Employees' Provident Fund (EPF), which is a fixed-income product, ELSS provides an opportunity for higher returns on their investment portfolios. Beyond delivering good returns over the long term, ELSS investments also qualify for tax deductions under Section 80C. While unit-linked insurance plans (ULIPs) and the National Pension System (NPS) offer similar benefits, they come with longer lock-in periods and potentially lower returns. ULIPs, for instance, have a lock-in period of five years, and NPS, designed more for retirement, involves partial exposure to equity with funds locked until the age of 60. ELSS funds, in contrast, have a shorter lock-in period of just three years.

First-time Investors: New investors find ELSS an excellent choice due to its tax benefits and an introduction to equity investing through mutual funds. While equity investments inherently carry higher short-term risks due to market volatility, these risks decrease significantly when investing for more than five years. Starting with monthly Systematic Investment Plans (SIPs) in an ELSS fund enables investors to accumulate more units during market downturns and potentially generate favorable returns during market upswings. This gradual investment approach aids in navigating the volatility associated with equity investments.

Key Considerations Before Investing in ELSS Funds

• Fund Returns: Evaluate the fund's performance by comparing it with competitors and benchmarks. While no fund stays at the top consistently, opt for funds that have a history of appearing in the top quartiles for extended periods.
• Fund House History: Choose fund houses with a consistent track record over five to ten years. A reliable history indicates the fund house's ability to manage investments effectively.
• Expense Ratio: Consider the expense ratio, indicating the portion of your investment allocated to fund management. Lower expense ratios translate to higher take-home returns, making such funds preferable.
• Financial Parameters: Analyze financial parameters like standard deviation, Sharpe ratio, alpha, and beta to assess fund performance. Higher standard deviation and beta imply greater risk, while a higher Sharpe ratio indicates better risk-adjusted returns.
• Fund Manager Expertise: Assess the competency and experience of the fund manager in selecting appropriate stocks and building a robust portfolio. A skilled fund manager is crucial for effective fund management.
• SIP or Lumpsum: Decide on the investment mode—Systematic Investment Plan (SIP) or lumpsum. SIP involves regular, typically monthly, investments, providing the benefit of cost averaging. On the other hand, lumpsum entails a one-time substantial investment.
• SIP Advantage: Considered the best option for most, SIP allows cost averaging, offering more units during market downturns and fewer units during upswings.
• Lumpsum Consideration: Suitable if you have surplus funds and prefer a one-time substantial investment.

ELSS Vs Other Tax-Saving Options

Explore various tax-saving instruments and their returns. Unlike fixed-return investments that may struggle against inflation, ELSS stands out by investing in equities with potential for higher returns. With a minimal lock-in period of 3 years, ELSS surpasses traditional options.

Advantages of ELSS Mutual Funds

Shortest Lock-in: ELSS has the briefest lock-in of three years, offering more liquidity than tax-saving FDs (5 years) and PPF (15 years).

Higher Returns: ELSS can provide significantly higher returns compared to other tax-saving options. With an average 15% long-term return, a monthly investment of ₹12,500 for 20 years could accumulate ₹1.89 Crores.

ELSS Category Average Rolling Returns (%)