ELSS Mutual Funds: Pros & Cons for Tax-Efficient Investing

An Equity Linked Savings Scheme, or ELSS, is an equity mutual fund scheme that primarily invests in equity and equity-linked instruments along with tax benefits under Section 80C of the Income Tax Act, 1961. In this article, we will look at the pros and cons of investing in ELSS schemes.

ELSS Explained

An ELSS fund is structurally like any other mutual fund where the fund manager pools money from investors with similar risk tolerances and investment goals. It is an equity fund that invests at least 80% of the fund’s assets in equity and equity-related instruments across varying risk levels. ELSS funds are different from other mutual funds since they offer tax benefits under Section 80C and have a mandatory lock-in period of three years.

Advantages of ELSS Mutual Funds

• Tax Savings

Equity-Linked Savings Schemes are the only equity funds that offer tax benefits. Investment in ELSS fund qualifies for tax deduction under Section 80C of the Income Tax Act, 1961. As per this Section, an investment of up to Rs.1.5 lakh in an ELSS scheme can be deducted from your taxable income every financial year. However, it is important to note that the tax benefits offered under Section 80C are applicable to all investments including ELSS funds. 

• Growth Potential

ELSS funds invest in the stock markets. Hence, if the fund manager chooses stock in sync with the market cycle, then these funds can offer good return potential.

• Lowest Lock-in Period

While the government has offered a list of investments under Section 80C for availing tax benefits, few of them have a lock-in period. A tax-saving fixed deposit has a lock-in period of five years, PPF has a lock-in of 15years, NSC has a lock-in period of five years, etc. Compared to all the options under Section 80C, ELSS funds have the lowest lock-in period of three years.

Disadvantages of ELSS Mutual Funds

• Market Risks

ELSS funds invest primarily in equity and equity-related instruments. Hence, there are market risks associated with ELSS funds. Unlike other tax-saving instruments, such as fixed deposits or PPF, there are no guaranteed returns when investing in ELSS. However, the high risk-return ratio combined with the lock-in period helps even out the market fluctuations and works in favour of long-term investors.

• Inability to Withdraw Funds

Since ELSS funds have a mandatory lock-in period of three years, you cannot withdraw your investments even if there is an emergency. However, this can also help instil financial discipline and long-term investment behaviour.

Key Takeaways

• An ELSS fund is a type of mutual fund that offers tax benefits.
• Among the various other Section 80C tax-saving instruments, ELSS comes with the lowest lock-in period and the highest growth potential.
• ELSS funds don’t offer fixed returns since they invest in the stock markets. 
• Investors can invest in ELSS either through a SIP or by making a lump-sum payment.

FAQs

Q1. What are the things to consider before investing in an ELSS fund?

1. While investing in mutual funds, it is important to consider the risk level and investment strategy adopted by the fund manager. Many investors buy ELSS units for saving tax but don’t pay attention to other details of the fund. Ensure that you fundamentally analyze the fund before investing. Also, since ELSS funds have a lock-in of three years, ensure that the money you invest in an ELSS fund is not required in the near term.

Q2. How to Invest in ELSS?

1. You can invest in an ELSS fund via the AMC, broker, or a new-age investment platform like Groww. There are two ways of making an investment:

1. SIP – Where you invest a fixed amount at regular intervals. This helps benefit from Rupee Cost Averaging and reduces the average cost of purchase per unit of the fund. Also, every installment has a lock-in period of three years.
2. Lump-Sum – You can also invest in an ELSS fund by making a lump sum payment. This carries a higher risk since you might end up buying at a market peak making profit generation a challenge.

Q3. Who should invest in ELSS funds?

1. ELSS funds are designed for investors looking to save tax while generating market-linked returns. There are different types of ELSS schemes available to cater to investors with varying risk tolerance levels and investment objectives.