Introduction:

ELSS mutual funds, which stands for Equity-linked Saving Schemes, are open-ended and equity-oriented investment vehicles known for their potential to deliver superior returns while also serving as efficient tax-saving instruments. Compared to alternative tax-saving options like PPF and FD, ELSS funds boast the shortest statutory lock-in period. Now, let’s delve into a comprehensive understanding of ELSS

ELSS Mutual Fund:

• ELSS, or Equity Linked Saving Scheme, is a mutual fund category characterized by allocating a significant portion, precisely 80%, of its corpus into equity investments, with the remaining 20% typically directed towards debt instruments.
• You can avail tax benefits of up to Rs. 1.5 lakh on ELSS investments. These funds have a lock-in period of 3 years, meaning you can only redeem your investments after this duration. This lock-in period is the shortest among all other tax-saving instruments.
• If you have an ELSS SIP, each installment would be subject to a lock-in period of 3 years, resulting in varying maturity dates for each installment.

Features of ELSS funds:

Below are the key characteristics of ELSS mutual funds:

• It features a mandatory lock-in period of 3 years with no early exit options available.
• The minimum investable amount varies among different fund houses, but there is no upper cap on the amount you can invest in ELSS.
• It offers returns that are linked to the market, with performance dependent on the underlying equities within the portfolio. 
• ELSS funds frequently mitigate concentration risk by diversifying their investments across various stocks from different industries.
• Under Section 80C, it allows for annual tax deductions of up to Rs 1,50,000.
• It allocates a minimum of 80% of its funds to stock investments, primarily in equities.
• Returns earned from investing in such Mutual Funds become taxable upon redemption of the units according to the prevailing tax regulations in India. The taxation rules on these returns are as follows:
• Short-term capital gains (STCG) refer to returns on investments held for 36 months or less. However, this criterion does not apply to tax-saving, as all have a mandatory lock-in period of at least 3 years.
• If investors sell their units in an ELSS fund after 3 years, the resulting returns are classified as long-term capital gains (LTCG). As per existing laws, gains up to Rs.1 lakh are exempt from taxes, while returns exceeding Rs.1 lakh are subject to a 10% tax rate.

Advantages of ELSS tax saving mutual funds:

Below are some benefits of investing in Equity Linked Saving Scheme:

• The top ELSS tax-saving mutual funds strategically invest in a diversified range of stocks across various sectors and market capitalizations to enhance returns while mitigating portfolio risk through diversification.
• While numerous mutual funds invest in equity and equity-related instruments, only ELSS schemes provide tax-saving benefits under Section 80C of the Income Tax Act, 1961. Investing in these funds offers the opportunity to save up to Rs. 1.5 lakh from your taxable income.
• ELSS schemes have a minimum investment value of Rs. 500. Additionally, investors have various investment routes to choose from, including SIP (Systematic Investment Plan), SWP (Systematic Withdrawal Plan), and lump sum investments. Therefore, you can select the option that best suits your preferences and financial goals.

How to Invest in ELSS Funds?

Below, we’ll explore the various methods for investing in ELSS mutual funds:

• Dividends: Opting for this choice grants investors the advantage of periodic dividend payouts. These dividends are included in one’s taxable income. However, the scheme distributes dividends solely in the event of substantial profits.
• Growth: Here, investors do not receive periodic dividends; instead, they accrue gains upon redemption. This fosters the appreciation of Net Asset Value (NAV), resulting in multiplied profits. However, it’s important to note that returns are subject to market risks.
• Reinvestment :In this option, investors reinvest the dividends they receive, which are then added to the Net Asset Value (NAV). This feature is particularly advantageous, especially during market upswings.

Things to be considered Before Investing:

• Prior to investing in a fund, it’s crucial to assess its performance relative to other funds and the benchmark to ascertain if it has consistently outperformed them in the past. While no fund can consistently maintain the top position, quality funds often persist in the top quartiles for prolonged periods.
• It’s prudent to choose fund companies with a track record of sustained success spanning between five and ten years.
• The expense ratio indicates the portion of your investment allocated to the operational management of the fund. Opting for a fund with a lower expense ratio can lead to higher returns, making investments in such funds more preferable.
• Before investing in ELSS, it’s important to decide between a SIP or lump sum strategy. SIP involves regular monthly investments, while lump sum entails a single significant payment. SIP offers cost averaging, acquiring more units during market downturns and fewer units during upturns. However, if you have extra cash, lump sum investment might be more suitable. Generally, SIP is considered the best option due to its cost-averaging benefits.

Tax Benefits:

• Under Section 80C of the Income Tax Act, investors can claim tax deductions on investments up to Rs. 1.5 lakh in ELSS mutual funds.
• In total, investors can save Rs. 46,800 annually in taxes on their investments. It’s important to note that while there is no maximum limit on the amount one can invest, there is a cap on the tax benefit.
• The capital gains earned by investors from their Equity-Linked Saving Scheme investments are treated similarly to equity instruments for Income Tax calculations. Consequently, the applicable tax rate for Short Term Capital Gains (STCGs) is 15%, while Long Term Capital Gains (LTCGs) are taxed at 10% if the amount exceeds Rs. 1 lakh in a financial year.

How to Redeem ELSS Funds:

• ELSS entails a lock-in period of 3 years, yet the redemption process varies for lump sum and SIP investments. For example, if you made a lump sum investment of Rs.10,000/- on 1st January 2021, you can only redeem it on or after 1 January 2024.
• However, the process differs slightly for SIP investments. With SIPs, you invest a fixed amount every month, meaning the lock-in period applies to each of your monthly investments individually.

Final Word:

While investing in ELSS tax-saving mutual funds offers significant benefits, such as tax exemption, it’s important to acknowledge the associated risks. Therefore, it’s crucial to carefully consider various aspects, including your risk appetite, investment objectives, and more, before making any investment decisions.