A beginner’s guide to investing in ELSS Mutual Funds

There are multiple types of mutual funds offered by asset management companies. This allows investors to choose the most suitable funds for them, primarily depending on their risk appetite and financial goals.

With one type of mutual fund, however, an investor can achieve the combined goals of efficient tax planning, along with long-term wealth creation. 

This is the Equity-Linked Savings Scheme, popularly known as an ELSS mutual fund.

What is an ELSS Mutual Fund?

An equity-linked savings scheme is a tax saving mutual fund, the investments of which can be claimed as tax-deductions.

These schemes, as the name goes, majorly invest in equities. Therefore, they offer combined high returns and long-term wealth creation with tax deductions.

How does an ELSS mutual fund work?

An ELSS mutual fund invests at least 80% of its total assets in equity related instruments, while the rest is invested across debt instruments.

Also, the fund invests across various capitalizations and sectors, but remains mainly in the equity category.

The ELSS fund is also one of the many savings instruments which allow for tax deductions under the Income Tax Act, 1961.

By investing in an ELSS fund, an investor can claim deductions under section 80C of the Act. The maximum deduction claimable is ₹1,50,000 per financial year.

Moreover, these mutual funds, unlike most funds, carry a lock-in period of three years. This lock-in period is essential for a tax-payer to be able to claim deductions.

Who should invest in an ELSS Mutual Fund?

An ELSS scheme is most suited for investors with high risk appetite and a long investment horizon. 

There are two reasons for this – one, the lock-in period that exists, and two, the ELSS scheme is an equity mutual fund.

Equity funds, as we all know, are one of the riskiest mutual funds, but also offer higher returns over a long investment duration.

The earlier you invest in these funds, the better. This is because, with the lock-in period, one can take better advantage of the compounding power of investments, and grow their wealth at a faster rate if they invest early.

How to invest in ELSS Mutual Funds?

There are multiple investment options through which one can accumulate wealth in an ELSS funds. These include – 

• Growth option –

Through this option, the dividends due on the shares invested are kept within the fund’s assets instead of being given to investors.

This helps to appreciate the total NAV of the investment and can improve returns.

• Dividend option –

Through this option, the investors are paid dividends as and when they become due on investments.

• Dividend reinvestment option –

Through this option, the dividends of investors will be reinvested into the mutual fund to increase their investment value.

• SIP Option –

Instead of investing a lump-sum amount, an investor can choose to start a Systematic Investment Plan or an SIP in an ELSS fund.

With an SIP, an investor can deposit a fixed amount of money for investment on a regular basis. Depending on the NAV of the fund, different number of mutual fund units will be purchased for the investor accordingly. 

Advantages of investing in ELSS Mutual funds:

• Lock-in Period:

Apart from ELSS mutual funds, the savings schemes under section 80C of the IT Act include various government backed schemes like provident funds and the National Pension System.

Out of all these products, the ELSS funds have the shortest lock-in period, of only three years.

This lock-in period helps investors to shift their money to better avenues if the scheme doesn’t perform well. This cannot be done for other products which have a much longer lock-in period.

Also, this lock-in period helps new investors practice financial discipline, as they will not be able to withdraw their investments out of any fear or greed prevailing in the stock markets.

• Market-linked returns:

An ELSS fund provides the multiple benefits of an equity mutual fund investment with tax saving benefits. 

These benefits include the potential for long-term wealth creation, and exponential, inflation-beating returns.

• No maximum investment:

A lot of savings schemes carry restrictions on investment, like a minimum age for investors, maximum and minimum investments, etc.

Unlike these, an ELSS fund only requires an investor to comply with KYC and be of the legal age to begin investing in it.

Moreover, there is no limit on the investment one can make in an ELSS fund, but a minimum of ₹1,50,000 needs to be invested per financial year to claim tax deductions.

How to choose the best ELSS fund for your portfolio?

Apart from the tax-saving benefit, an ELSS fund, at its core, is an equity fund that invests across multiple capitalizations and sectors.

Therefore, to choose the best ELSS fund, one should focus on the basic parameters to compare funds.

These include – 

1. The fund’s current performance – its returns in comparison to other ELSS funds;
2. The fund’s history, whether it has been able to deliver consistent results over the years;
3. The expense ratio, which is deducted from the NAV before calculating the investment’s return;

An investor can also use various financial ratios, like the Sharpe ratio, Treynor ratio, etc., to make an informed investing decision.

An investor should carefully evaluate their financial goals, and compare each type of fund available before they begin investing in mutual funds.

They can do this with the help of StockEdge, which provides investors with all the relevant information they will need to make a suitable investment decision. 

By keeping the above points in mind before choosing an ELSS fund, an investor will be able to derive the maximum benefits of their investments, coupled with tax savings.