Benefits of ELSS Mutual Funds
What are Tax saving Mutual Funds?
Tax-saving mutual funds, or Equity Linked Savings Schemes (ELSS), offer the dual advantage of reducing your tax liability and building wealth. These funds primarily invest in equity and equity-related instruments, allowing investors to benefit from the growth potential of the stock market. Alongside tax savings, these funds aim to create long-term wealth, making them an excellent option for those looking to grow their money while reducing their tax burden.
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Tax Benefits of ELSS
ELSS (Equity Linked Savings Scheme) is an excellent option for those looking to save on taxes under Section 80C of the Income Tax Act. When you invest in these funds, you can deduct up to ₹1.5 lakh from your taxable income for the year, lowering your overall tax liability. Moreover, the returns from ELSS are subject to Long-Term Capital Gains (LTCG) tax on gains, which is much lower than the highest tax slab rate.
ELSS vs Other Tax-Saving Options
Higher Returns: ELSS offers significantly higher growth potential compared to traditional tax-saving options like fixed deposits, PPF, or NSC. Since ELSS invests in equities, it leverages the long-term growth potential of the stock market, often outperforming fixed-income instruments.
Shortest Lock-In Period: With a lock-in period of just three years, ELSS is far more flexible than other Section 80C options. In comparison, PPF has a lock-in of 15 years, NSC requires 5 years, and tax-saving fixed deposits are locked for 5 years as well.
Long-Term Wealth Creation: Staying invested in ELSS for longer than the mandatory three years can further enhance returns, as equities tend to perform better over extended periods.
Comparison with Alternatives:
- PPF: Provides stable, fixed returns (~7-8%), but with a 15-year lock-in.
- NSC: Safe option with moderate returns (~7%), but returns are fully taxable.
- Tax-Saving FDs: Offers ~6-7% returns with a lock-in of 5 years and no exposure to equity growth.
Returns and Risk of ELSS
ELSS funds have the potential to deliver higher returns compared to other tax-saving options, thanks to their equity exposure. However, this also means they carry a higher level of risk. Returns in ELSS are directly linked to market performance, so there’s no guarantee of fixed returns, unlike traditional instruments like PPF or FDs.
ELSS investments can experience short-term fluctuations, as they are linked to the performance of the stock market. While they have strong long-term growth potential, their value may rise and fall in the short run. This volatility is part of the nature of equity-based investments, which can be unsettling for some investors. However, staying invested for the long term can help ride out these fluctuations and benefit from the overall market growth. Remember, patience and consistency are key when investing in ELSS.
Who Should Invest in ELSS?
ELSS is ideal for taxpayers seeking tax-saving options with the added benefit of long-term growth potential. It suits investors with a moderate to high-risk tolerance, given its equity exposure.
For new investors, selecting the right active ELSS fund can be overwhelming, especially when the fund underperforms. To begin their investment journey, they can consider ELSS funds as the lock-in period teaches patience and long-term discipline.
Alternatively, passive ELSS funds are a simpler option. They follow a specific index, requiring less hands-on management. This means you don’t have to worry about fund managers actively picking stocks. For those who prefer a steady and more predictable approach, passive ELSS funds can be a great choice. They still offer tax-saving benefits, but with fewer decisions to make along the way.
Passive ELSS funds are a great choice for investors who have a conservative to moderate risk tolerance. They strike a good balance between offering decent returns and maintaining stability. For example, the Zerodha ELSS Tax Saver Nifty LargeMidcap 250 Index Fund is a passive ELSS fund designed to help investors start with ease.
Choosing the Right ELSS Fund
When selecting an ELSS fund, consider key factors such as past performance, fund manager expertise, and the expense ratio. It’s essential to align the fund with your financial goals and risk tolerance.
To evaluate performance, compare the fund’s 7–10-year returns against its benchmark and category average. Experienced investors may also analyze rolling returns to assess consistency. Additionally, examine metrics like volatility (standard deviation) and risk-adjusted returns using ratios such as Sharpe and Treynor. These tools help gauge how well the fund balances risk and returns.
For passive ELSS funds, focus on the expense ratio and tracking errors, as these can influence your returns. Whether you choose active or passive ELSS funds, ensure you have a minimum investment horizon of 5-7 years to maximize their wealth creation potential while enjoying tax benefits. Thoughtful selection can balance risk, returns, and tax savings effectively.
Five ELSS Mutual Funds to Consider
Fund Name | 5-Year Returns | Expense Ratio |
Quant Tax Plan | ~33% | 0.57% |
Mirae Asset Tax Saver Fund | ~22% | 0.60% |
DSP Tax Saver Fund | ~23% | 0.75% |
Bank of India Tax Advantage Fund | ~27% | 0.80% |
Zerodha ELSS Tax Saver Nifty Largemidcap 250 Index | ~27% (one year return) | 0.27% |
Final Take on ELSS Mutual Funds
ELSS funds teach disciplined investing because of the mandatory lock-in period of three years. This period not only prevents impulsive withdrawals but also gives your investment the time to grow. Staying invested beyond the lock-in allows you to tap into the power of compounding, turning your money into a growing asset over time.
Because the money is locked in, fund managers can focus on long-term opportunities that may take a few years to show returns. This gives ELSS funds a better chance to generate higher returns compared to funds without a lock-in period.
For those aiming to maximize returns from their tax-saving investments, ELSS is an excellent choice. It offers the dual benefit of tax-saving and wealth creation, helping you achieve long-term financial goals.
