ELSS or Equity Linked savings schemes are a kind of tax-saving mutual fund which is considered a good investment option for investors who aim to save taxes while creating wealth in tandem.
ELSS mutual funds primarily invest in stocks of listed companies in a specific proportion based on the investment objective of the fund. The stocks invested are chosen from across the various market capitalization. Investments of up to 1.50 Lakh done in a financial year in ELSS Funds is eligible for tax deduction under section 80C of the Income Tax Act 1961.
One can invest in ELSS through SIP or a one-time investment. It is important to understand here that taxes through investment can be saved either through risk-free or low-risk and market return-linked schemes. The former consists of PPF or Public Provident Fund, NSC or National Savings Certificates, traditional insurance policies and tax saving FD, etc. The latter consists of ELSS mutual fund schemes and ULIPs or Unit Linked Insurance Plans. In risk-free schemes, capital safety is assured whereas market return-linked schemes are subject to market risks. Investors wanting total safety of the capital should only opt for assured return schemes for their tax saving purposes.
Comparison with other tax saving options
Let us now compare tax-saving mutual funds with other options in the financial markets which help investors with the purpose of tax saving:
- PPF or Public Provident Fund has a lock-in period of 15 years. If one wants to withdraw money prior to that, it is possible from the 5th year but only to a limited extent.
- Traditional life insurance policies have lock-in periods of 15-25 years typically. It varies, depending on the type of policy you have chosen. If a premature withdrawal is needed in this case, surrender charges will be applicable.
- ULIP Insurance plans have a lock-in period of a minimum of 5 years but returns are not assured.
- NSC and bank tax saving fixed deposits have lock-in periods of 5 years and premature withdrawal of money is strictly not allowed.
- ELSS has a lock-in period of 3 years and the historical returns have been much higher than assured return schemes. For example ELSS funds as a category have given over 18% and 10% average returns in the last 3 and 5 years period respectively (Returns as on Oct 19, 2022. Source: www.advisorkhoj.com)
Thus, it is clear from the above examples that tax-saving mutual funds or ELSS mutual fund investments have the shortest lock-in period and the highest returns. After the lock-in period, an investor is free to withdraw the money or remain invested for the purpose of capital appreciation.
How to invest in ELSS funds?
With many advantages for investors, one can invest in ELSS funds and can also choose from a growth option or dividend payout option. In the case of the growth option, the investor will not receive any immediate returns and the same will compound in the scheme whereas, in the case of dividends, the gains may be paid periodically. However, investors should note the scheme NAV will go down to the extent of the dividend declared percentage.
We compared the ELSS mutual fund with other investment options which help in tax saving. The aim here is to understand that ELSS funds are the most beneficial for an investor looking to get dual benefits from a single investment option.