The equity-linked saving scheme (ELSS) is a category of mutual funds that the government created to encourage long-term equity investments. Through ELSS scheme, the government sought to improve equity participation by allowing tax-deductible investment in equity-based mutual funds. A tax deduction encourages the average citizen to invest a larger part of his savings in equities, and ELSS mutual funds can benefit him in multiple ways.
However, you should know a few important things before you invest. Here are the 6 things that you must know about ELSS mutual funds:
What are ELSS funds?
ELSS funds are equity-oriented mutual funds that aim to invest in equity and equity-related securities. Some funds also put a portion of their investment corpus in debt securities. The broad aim of ELSS funds is to focus on generating investor wealth over the long term.
How much should you invest in ELSS funds?
An investor can put his money in ELSS mutual funds either as a lump-sum or using a systematic investment plan (SIP). An SIP approach is better as it allows you to invest in a planned and disciplined manner. SIP gives you two advantages. One, breaking up your tax savings over twelve months reduces the effect that the investment would have on your liquidity. Two, SIP gives you the benefit of rupee-cost averaging. Buying an ELSS mutual funds with a lump-sum approach means you end up missing on buying at the best possible price.
How do ELSS funds give you tax benefits?
Investments in ELSS mutual funds are deductible from your gross income under Section 80C of the Income Tax Act. However, you can invest only up to ₹.1.5 lakh in any particular financial year. ELSS schemes also enjoy the benefit of being Exempt, Exempt, Exempt (EEE). What this means is that you get tax benefits when you invest in an ELSS mutual funds; the dividends you receive are tax-free; and there are no capital gains at the time of redemption.
What is the lock-in period for ELSS funds?
The lock-in period is three years. During this period, you cannot redeem any of your units. However, you can receive dividend payments. This lock-in period here is much less than other tax-saving instruments like Public Provident Fund, Fixed Deposit and Kisan Vikas Patra.
How do ELSS funds generate returns?
ELSS mutual funds does not offer guaranteed returns, but it does offer market-linked returns. As there is a lock-in of three years, you are able to benefit by staying in the market for a longer time. This helps compound your wealth by remaining invested in the market and not selling during temporary stock market corrections.
How exactly does ELSS funds work?
Your ELSS investment can help you put your hard-earned money to good use in a way that you save on taxes and also create long-term wealth. Here is an example of how it works.
Example: Let us assume that the net asset value of your ELSS mutual fund is ₹ 30. If you have ₹ 1,50,000 that you can invest under Section 80C, you can buy 5,000 units of the ELSS mutual fund. As you are in the highest tax bracket, you will get an exemption of 30% on this investment. To simplify the example, we are ignoring surcharge and cess. So, on an investment of ₹ 150,000, you get a tax rebate of ₹ 45,000. So, your effective investment in the ELSS mutual fund comes down to ₹ 1,05,000.
ELSS funds have averaged an annualised return of around 13.8 per cent over the past three years. So, assuming an annual return of around 13 per cent, the NAV of the fund has appreciated to ₹ 43 at the end of three years. Therefore, the value of your investment has increased from ₹ 1,05,000 to ₹ 2,16,000 in three years. This is nearly double of your investment and illustrates the power of compounding, combined with tax savings you get from ELSS investments.
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So, invest smart, save tax, and create wealth!