What Is ELSS Mutual Fund

What is ELSS Mutual Fund?

ELSS Mutual Fund full form is Equity-Linked Saving Schemes, it is a tax-saving mutual fund that invests primarily in equity shares of companies. The primary objective of these funds is to provide wealth appreciation in the long run and help investors to save tax.

Investing in an ELSS fund helps you exempt tax of up to INR 1.5 lakh in a financial year U/S 80C of the Income Tax Act. They have a lock-in period of three years, which means you can not redeem your funds before three years. 

This article covers: 

Features Of ELSS Funds

One of the most important features of ELSS mutual funds is the tax-saving benefit under Section 80C of the Income Tax Act, up to a limit of Rs. 1.5 lakhs per financial year. 

Let’s have a look at some more features of ELSS funds:

1. Dividend and Growth Options

ELSS funds offer two options to investors – Dividend and Growth. In the dividend option, the fund pays out dividends to the investors from time to time. In contrast, in the growth option, the investor’s money remains invested, and the gains are reinvested to generate more returns.

2. Tax benefits

One of the significant advantages of investing in ELSS funds is the tax benefits they offer. ELSS funds are eligible for tax deduction under Section 80C of the Income Tax Act, which allows taxpayers to claim a deduction of up to INR 1.5 lakhs in a financial year.

For instance, if a taxpayer invests INR 1.5 lakhs in ELSS funds, they can claim the entire amount as a deduction from their taxable income, reducing their tax liability. Additionally, ELSS funds have a lock-in period of three years, which is the shortest lock-in period among all tax-saving investments.

3. Systematic Investment Plan

ELSS funds also offer the option of investing through a Systematic Investment Plan (SIP), which allows investors to invest a fixed amount at regular intervals. This option helps reduce the timing risk of market fluctuations and helps investors take advantage of rupee-cost averaging.

4. Lock-in Period

ELSS funds have a lock-in period of three years, which means that the investor cannot withdraw their money before the completion of the lock-in period. However, after the completion of the lock-in period, the investor can withdraw the money or continue investing in the fund.

5. Professionally Managed

ELSS funds are managed by professional fund managers who are experts in equity investments. They use their expertise to select the best stocks for investment and make portfolio adjustments as per market conditions.

6. Balanced and Diversified Investment

ELSS funds invest in a diversified portfolio of stocks across various sectors and market capitalizations. This diversification helps in reducing the risk of concentration in a single stock or sector.

For example, if an investor invests in an ELSS fund that invests in large-cap stocks, mid-cap stocks, and small-cap stocks, the portfolio diversification ensures that the investor’s money is spread across a broad range of companies. This reduces the risk of concentration in a single stock or sector and helps achieve better risk-adjusted returns.

Types Of ELSS Mutual Funds

The types of ELSS mutual funds are Growth Option, Dividend Option, and Dividend Reinvestment Option. 

1. Growth Option 

In the growth option of an ELSS mutual fund, the returns on investment are reinvested into the fund. The investor does not receive any dividends, but the value of their investment keeps growing over time. At the end of the lock-in period, the investor can redeem the units to receive the returns on their investment.

For example, let’s say that an investor invests INR 50,000 in an ELSS mutual fund through the growth option. The fund has an annualized return of 12%, and the lock-in period is three years. At the end of three years, the value of the investment would be INR 77,000 (50,000 x 1.12^3). The investor can then redeem the units to receive the returns on their investment.

2. Dividend Option  

In the dividend option of an ELSS mutual fund, the fund periodically distributes dividends to the investors. The frequency of the dividend payout can vary from fund to fund, and the amount of the dividend can depend on the fund’s performance.

For example, if an investor invests INR 50,000 in an ELSS mutual fund through the dividend option, and the fund declares a dividend of 10%, the investor would receive a dividend of INR 5,000 (50,000 x 0.1). The investor can choose to reinvest the dividend in the same fund or receive the dividend as cash.

3. Dividend Reinvestment Option

 In the dividend reinvestment option of an ELSS mutual fund, the dividends declared by the fund are reinvested into the fund. The investor does not receive any cash payouts but benefits from the compounding effect of reinvesting the dividends.

ELSS Tax Benefits 

1. Shortest lock-in

ELSS mutual funds have the shortest lock-in period of just three years, which is the lowest among all tax-saving investment options under Section 80C of the Income Tax Act. This means that investors in ELSS funds can enjoy tax benefits on their investments while also enjoying the flexibility of being able to redeem their units after just three years.

2. Better returns

ELSS mutual funds have historically generated higher returns than other tax-saving investment options. Over the last five years, the average annual returns of ELSS mutual funds have been around 12-15%, while other tax-saving investment options such as PPF and NSC have offered returns in the range of 7-8%. 

This means that investing in ELSS mutual funds can help investors earn higher returns while also providing tax benefits.

3. Higher after-tax returns

ELSS mutual funds also offer better post-tax returns compared to other tax-saving investment options. This is because long-term capital gains (LTCG) from ELSS mutual funds are tax-exempt up to Rs. 1 lakh per financial year.

In comparison, LTCG from other tax-saving investment options such as PPF and NSC are taxable. This means that investing in ELSS mutual funds can help investors earn higher post-tax returns.

4. Hassle-free and convenient

 Investing in ELSS mutual funds through a systematic investment plan (SIP) is a hassle-free and convenient way to invest in a tax-saving instrument. SIP allows investors to invest a fixed amount at regular intervals, such as monthly or quarterly, into their ELSS mutual fund. 

This helps inculcate financial discipline and ensures that investors invest regularly toward their tax-saving goals. In comparison, other tax-saving investment options, such as PPF and NSC, do not offer the convenience of regular investing through SIP.

ELSS vs Mutual Fund 

The main difference between ELSS and Mutual Funds is that ELSS funds are a type of equity fund that allows you to save tax of up to Rs. 1.5 lakhs in a financial year. On the other hand, mutual funds are a type of fund that pools money from different investors to invest in a diversified portfolio of assets such as stocks, bonds, and other securities. 

1. Lock-in Period 

  • ELSS funds have a mandatory lock-in period of three years, whereas regular mutual funds do not have a mandatory lock-in period.
  • The lock-in period in ELSS funds is intended to encourage long-term investments and is also required to claim tax benefits under Section 80C.

2. Tax Benefits

  • ELSS funds offer tax benefits to investors under Section 80C of the Income Tax Act. Investors can claim a tax deduction of up to Rs. 1.5 lakhs per financial year on their investment in ELSS funds. This tax benefit is not available for regular mutual funds.

3. Liquidity

  • Regular mutual funds offer higher liquidity compared to ELSS funds. As mentioned earlier, ELSS funds have a mandatory lock-in period of three years, whereas regular mutual funds do not have a lock-in period.

While regular mutual funds offer higher liquidity and flexibility, ELSS funds offer tax benefits and a lock-in period that encourages long-term investments. Investors should consider their investment goals and risk profile while choosing between ELSS and regular mutual funds.

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What is ELSS Mutual Fund- Quick Summary 

  • ELSS mutual funds are tax-saving investment options in India.
  • Features of ELSS funds include professional management, diversified investment, and the option for systematic investment plans.
  • There are three dividend options for ELSS funds: growth, dividend, and dividend reinvestment.
  • ELSS funds offer tax benefits, including the shortest lock-in period among tax-saving investments.
  • ELSS funds come in growth, dividend, and dividend reinvestment options.
  • ELSS funds offer higher returns and better post-tax returns than other tax-saving investments.
  • Regular investing in ELSS funds is hassle-free and convenient.
  • ELSS funds have a shorter lock-in period compared to other tax-saving investments.
  • ELSS funds offer liquidity through partial withdrawals after the lock-in period.
  • Top tax-saving mutual funds include Axis Long Term Equity Fund and Aditya Birla Sun Life Tax Relief 96.
  • Investors can claim a tax deduction of up to Rs. 1.5 lakhs per financial year on their investment in ELSS funds. On the other hand, investing in other types of mutual funds does not offer any tax benefits.

What is ELSS Mutual Fund- FAQs

1. What is an ELSS Mutual Fund?

ELSS (Equity-Linked Savings Scheme) is a type of mutual fund that invests primarily in equity shares and offers tax benefits under Section 80C of the Income Tax Act.

2. Is ELSS better than SIP? 

ELSS and SIP are two different investment options and cannot be compared directly. SIP (systematic investment plan) is a method of investing in mutual funds, including ELSS funds, where investors can invest a fixed amount at regular intervals. 

3. Can I withdraw from ELSS after 5 years? 

Yes, investors can withdraw their investments in ELSS funds after the mandatory lock-in period of three years. There is no maximum lock-in period for ELSS funds, and investors can hold their units for as long as they want.

4. What are the disadvantages of ELSS? 

The disadvantages of ELSS funds include the mandatory lock-in period of three years, which may limit liquidity in the short term. Additionally, ELSS funds are subject to market risks, and the returns on these funds may be volatile.

5. Why is ELSS risky? 

ELSS funds primarily invest in equity, making them subject to market risks. The stock market can be volatile and may cause fluctuations in the returns on ELSS funds.

6. Is ELSS better than PPF? 

ELSS and PPF (public provident fund) are two different investment options with different features. ELSS funds offer higher potential returns compared to PPF, but they are also subject to market risks. PPF, on the other hand, offers a fixed return with low risk. 

7. Is ELSS tax-free? 

Investors can claim a tax deduction of up to Rs. 1.5 lakhs per financial year on their investment in ELSS funds. However, long-term capital gains (LTCG) from ELSS funds are taxed at 10% if the capital gains earned on the fund is more than Rs. 1 lakh per financial year.

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