What is ELSS Mutual Funds?
ELSS (Equity Linked Savings Scheme) is a type of diversified equity mutual fund that invests a majority of its funds in equity and equity related schemes. ELSS investments have a lock-in period of three years. During the lock-in period, an investor cannot redeem or transfer the units to another scheme. However, investors can claim the tax benefits for the financial year in which they have invested in the ELSS. Investors can also opt for either SIPs or one-time lump sum investment when investing in an ELSS tax saver fund of their choice.
Open-End ELSS:
Under this scheme, the investors can invest in an ELSS at any given time as per their preference. The 3 year lock-in period is however applicable, but once the lock-in period ends, redemptions can be made at any time of the investor’s choice.
Closed-End ELSS:
Close-ended ELSS only takes investment during the NFO (New Funds Offer) period and after that, they are closed for investments. Additionally, the investors can liquidate their investment in the closed-end fund after completion of the 3-year lock-in at only specific periods of time as declared by the fund from time to time.
Features of ELSS:
Some key features and characteristics of ELSS Tax Saver Schemes include the following:
- Many investors use SIP to invest in ELSS mutual funds, which is a good way to ensure the regular flow of money. This also ensures rupee cost averaging that partially nullifies stock market volatility.
- There is no sudden outflow in ELSS as the investment is locked for a period of three years. Even in tough market conditions, investors cannot redeem their investment. This helps prevent outflows and investor panic during a bear run leading to increased chances of capital appreciation.
- The primary aim of an ELSS is capital appreciation. Being an equity-linked scheme, these are usually high-return assets however, being market-linked, there is no guarantee of returns.
- Despite their short lock-in period, ELSS mutual funds have historically given considerably higher returns compared to NSC, PPF, VPF etc. that have longer lock-in periods.
- ELSS has no upper limit which means that investors may invest as much as their risk appetite allows in equities to avail higher returns. These returns are also tax-free, making them a smart choice for investors. However, investors can claim only Rs. 1.5 lakhs as tax exempt under Section 80C.
ELSS as a Tax-Saving Instrument:
ELSS qualifies for tax exemption of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act. However when compared to other tax saving options like Mutual Funds, NPS, PF, Term Insurance, etc. these tax savings mutual funds have the shortest lock-in period of 3 years.
ELSS Compared to Other Tax-Saving Options:
A comparison of ELSS with other popular tax-saving instruments will help you understand its efficacy and benefits.
| Parameters | NSC | PPF | ELSS |
| Lock-in Period | 6 Years | 15 Years | 3 Years |
| Min. Investments | Rs. 100 | Rs. 500 | Rs. 500 |
| Max. Investments | No limit | Rs. 1,00,000 | No Limit |
| Returns | Compounded Half-Yearly, Currently 8% | Compounded Annually, 8% | Dividends/ Returns linked to Market (Average of 15% over the past 5 years) |
| Exempted Amount Under Section 80C | Rs. 1,50,000 | Rs. 1,50,000 | Rs. 1,50,000 |
| Tax on Interest | Taxable | Tax-free | Tax-free Dividends and Capital Gains |
| Risk Index | Medium (partial exposure to equity) | Low | High (Subject to Market Risk) |
Here are some of the important factors to consider before investing in an ELSS.
Review Past Trends: Reviewing past performance helps you determine how well the tax saver scheme has performed since inception. ELSS mutual fund performance records and benchmarks are available from multiple sources, which help the prospective investor make an informed investment decision. However, past performance is not an indicator of how well a fund will perform in the future.
Transaction Costs: When you are investing through a third-party, you might often be charged a transaction fee and this fee would reduce your potential earnings from the ELSS tax saver scheme. It is therefore preferable to seek out options such Paisabazaar.com that allows you to invest in ELSS mutual funds of your choice without levying any additional charge. In case you are being charged a fund management fee by your current fund advisor, you can choose to transfer your current portfolio to Paisabazaar.com at no extra cost.
Fund Size: Funds that have historically performed well and have strong fundamentals are favoured by investors. Thus top performing ELSS mutual funds often feature a larger AUM (assets under management) than funds that have underperformed in the past. Hence, when making a comparison between various ELSS tax saver funds, the size of the fund is usually a good indicator of which fund would be a better option to invest in. That said, this criterion does not hold true in case of new fund offers or newly launched ELSS mutual funds.
Fund Rating: ELSS schemes are rated by various rating agencies such as CRISIL on the basis of their performance and risk factors. While some schemes offer high returns and thus have high ratings, they may be offset by a higher risk, whereas others offer a balance of both. Schemes which feature a balance of performance and risk are often preferred by conservative investors, whereas, more risk tolerant investors prefer to invest in relatively higher risk funds. However, it is important to note that fund ratings are based on historic performance and it can in no way ensure how the fund might perform in the future.