There are three categories of mutual funds on the basis of asset classes – equity funds, hybrid funds and debt funds. Equity funds invest in equity and equity related securities, while debt funds invest in debt and money market securities. Hybrid funds invest in equity, debt and money market securities. These different types of mutual funds are suitable for different risk appetites and investment needs. However, for the purposes of tax savings investments in mutual funds, only Equity Linked Savings Schemes or ELSS funds, a type of equity mutual fund scheme which is eligible for claiming tax deductions of upto Rs 150,000 from your taxable income under Section 80C of Income Tax Act 1961.
What is ELSS?
ELSS funds are equity mutual fund schemes which is eligible for tax savings u/s 80C. ELSS is nothing but a diversified equity mutual fund scheme with a lock-in period of 3 years and offers tax saving benefits under section 80C. ELSS diversify investments across different sectors and companies irrespective of their market capitalization.
You can start investing in ELSS with Rs 100 only. There is no upper limit of investments in ELSS; but, you can claim tax deduction of up to Rs 1.5 lakhs u/s 80C. You can invest in ELSS funds either in lump sum or through SIP. You can also invest in ELSS funds through SIP, but remember that each SIP instalment gets locked in for 3 years.
Why invest in ELSS?
- Historical data shows that equity, as an asset class, has the potential of giving superior returns in the long term. In the last 20 years (ending 31st August 2022) Nifty 50 TRI has given 17% CAGR returns. Rs 10,000 invested in Nifty 50 TRI 20 years back, would have multiplied to around Rs 2.2 lakhs (see the chart below).
Source: National Stock Exchange, www.advisorkhoj.com Research. Date range: From 01/09/2002 to 31/08/2022. Disclaimer: Past performance may or may not be sustained in the future
- Since ELSS funds can invest across various sectors and market capitalization, there is scope for the fund manager to generate alphas by investing in a bigger universe of stocks. Historical data shows that there is greater potential of alpha generation in small / midcap market cap segments.
- The three year lock-in period of ELSS funds enables fund managers to invest in high conviction stocks for a long period of time because of relatively less redemption pressure when ELSS units are locked in.
- ELSS is the most liquid investment option u/s 80C. ELSS has lock-in period of 3 years, whereas minimum lock-in period of other 80C investment options is 5 years.
- ELSS is one of the most tax efficient investment options u/s 80C. Capital gains of up to Rs 1 lakh in in a FY is totally tax free and thereafter the gains are taxed only at 10%. You can also invest in the IDCW option and in that case the dividends received will be added to your income and taxed as per your income tax slab applicable to you.
Who should invest in ELSS?
- Investors looking for tax savings and wealth creation over long investment tenures. You can save up to Rs 46,800 per year in taxes by investing in ELSS funds.
- Investors with high to very high risk appetite.
- Investors with minimum 3 year investment tenures. ELSS investments are liquid after 3 years, but you should ideally have 5 years plus investment tenures for ELSS funds as these are equity schemes.
