ELSS Mutual Funds – Know How You Can Save Your Tax

Also known as tax-saving mutual funds, ELSS mutual funds, full form Equity-linked Saving Schemes, are open-ended and equity-oriented mutual funds. These funds have the potential to generate higher returns and are also an effective tax-saving instrument. 

ELSS funds have the least statutory lock-in period among other tax-saving options, such as PPF and FD. 

Let’s understand ELSS mutual funds in detail.

What is ELSS Mutual Fund?

ELSS or Equity Linked Saving Scheme is a type of mutual fund that invests a major portion of its corpus – 80% to be precise – in equity. The remaining 20% is invested in debt instruments. 

You can claim tax benefits of up to Rs.1.5 lakh for ELSS investments. These funds come with a lock-in period of 3 years, meaning you can only redeem your investments after three years. The lock-in period is the lowest among all other tax-saving instruments. 

Point to note – if you have an ELSS SIP, each instalment would come with a lock-in period of 3 years and would have a different maturity date.

How ELSS Mutual Funds Work?

Equity Linked Savings Schemes or ELSS are classified as diversified equity funds. Fund managers of these funds invest mostly in a wide variety of stocks of listed companies. 

The investments are made in specific proportions based on the objective of the fund.  The fund manager selects stocks from across market capitalisation, including large cap, mid cap and small cap and other relevant industry sectors

ELSS mutual fund schemes aim to generate optimum returns over the long run. Currently, as per SEBI guidelines, fund managers are allowed to invest 80% of the corpus in equities and 20% in debt instruments.

Who Should Invest in ELSS mutual funds?

ELSS mutual funds are suitable for investors who are looking to invest in equity and save tax under Section 80C of the Income Tax Act. Since these mutual fund schemes primarily invest in stocks, they carry high financial risk. That said, these funds have the potential to generate higher returns in comparison to other tax-saving schemes owing to the equity exposure. 

Hence, for individuals, it is key to assess their risk profile before allocating funds to any of the best ELSS funds in India.

Advantages of Investing in ELSS tax saving mutual funds

Here are a few benefits of investing in Equity Linked Saving Scheme:

1. Portfolio Diversification

The best ELSS tax saving mutual funds invest in a range of stocks with different market capitalisation across various sectors to generate higher returns. This diversification reduces portfolio risk. 

2. Tax Benefits

Several mutual funds invest in equity and equity-related investment instruments. However, except for ELSS schemes, none offer tax-saving benefits under Section 80C of the Income Tax Act, 1961. These funds present you with the opportunity to save up to Rs.1.5 lakh from your taxable income.

3. Investment Flexibility

ELSS schemes come with a minimum investment value of Rs.500. Moreover, individuals have multiple investment routes to choose from, including SIP (Systematic Investment Plan), SWP (Systematic Withdrawal Plan), and lump sum. Thus, you can choose whichever option is best suited for you. 

Also read: Advantages and disadvantages of ELSS funds

Features of ELSS Funds

Here are some of the features of ELSS funds:

• According to SEBI (Securities and Exchange Board of India), all ELSS mutual funds need to mandatorily invest at least 80% of their corpus in equity and equity-related instruments.
• Funds are allocated to various stocks across different sectors and market capitalisation, keeping in mind investment objectives and risk potential.
• These funds have a minimum lock-in period of three years. However, there is no limit to the time horizon of your investment after this three-year period.
• Investments worth up to Rs.1.5 lakh in tax-saving mutual funds are eligible for tax deduction benefits from your annual taxable income as per Section 80C of the Income Tax Act, 1961 
• Returns earned from investing in such mutual funds are taxable upon redemption of the units as per the existing tax norms in India. Taxation rules on these returns are:

STCG

STCG or short term capital gains are returns on investments held for 36 months or less. This does not apply in the case of tax saving mutual funds, as the mandatory lock-in period for all ELSS mutual funds is at least 3 years.

LTCG

If investors sell their units in an ELSS fund after 3 years, the realised returns are referred to as long-term capital gains (LTCG). According to existing laws, such gains of up to Rs.1 lakh are exempted from taxes. Returns exceeding Rs.1 lakh are taxed at 10%. 

How to Identify the Best ELSS Funds?

If you wish to identify the best ELSS mutual funds, you need to check the following parameters:

Market cap of stocks in the portfolio

If an Equity Linked Savings Scheme has a high concentration in large-cap stocks, it ensures stability with respect to returns and risk ratios. Compared to them, ELSS funds that have a high concentration in mid or small-cap stocks tend to be more volatile. 

As a result, they usually carry high risks as well. However, investors who prefer high potential returns may choose them.

Expense ratio

It is a good idea to look for an ELSS fund with a low expense ratio. This is because a high expense ratio reduces returns from your investment.

Past performance

Financial experts recommend choosing a fund that has performed well consistently for the previous 5 to 10 years. It is also a good idea to compare the fund’s performance with its competitors and the underlying benchmark. 

If a fund has outperformed its competitors and benchmark, it may be efficiently managed and capable of generating good returns. However, past performance shouldn’t be considered as a benchmark while selecting mutual funds.

Fund manager

The fund manager is wholly responsible for managing a mutual fund. So, it is essential to evaluate the expertise and record of a fund manager before investing. They must have solid knowledge and experience in picking stocks to create a good portfolio.

Financial parameters

Evaluating other financial parameters like Standard Deviation, Alpha, Beta, and Sharpe Ratio helps investors make better investment decisions. For example, choosing a scheme with a higher Sharpe Ratio means a high change of getting better risk-adjusted returns.

How to Invest in ELSS Mutual Funds?

Discussed below are the different ways of investing in ELSS mutual funds:

1. Dividend Option

If investors choose this option, they will get the benefit of receiving dividends periodically. Dividends are added to one’s taxable income. However, the scheme generates dividends only in case of excessive profits.

 2. Growth Option

Here, investors do not receive dividends periodically. Instead, they will receive the gains during redemption. This facilitates the appreciation of NAV which further leads to profits multiplying. But please remember that returns are subject to market risks.

3. Dividends Reinvestment Option

Under this option, the investor reinvests the dividends he has received. These get added to the NAV. This facility Is beneficial, especially when the market sees upswings.

Tax Benefits of ELSS Funds

According to Section 80C of the Income Tax Act, investors can seek tax deductions on investments up to Rs. 1.5 lakh in ELSS mutual funds. 

In total, investors can save Rs.46,800/- annually in taxes on their investments. Please note that there is no maximum limit on the amount one can invest, though there is a cap on the tax benefit.

The capital gains that investors earn from their Equity-Linked Saving Scheme investments are treated like equity instruments when it comes to Income Tax calculations. 

Therefore, the applicable tax rate for STCGs (Short Term Capital Gains) is 15%. LTCGs (Long Term Capital Gains) are taxed at 10% if the amount exceeds Rs.1 lakh in a financial year. 

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How to Redeem ELSS Mutual Funds?

ELSS comes with a lock-in period of 3 years. However, the redemption works differently for a lump sum and SIP investments. For instance, if you have made a lump sum investment of Rs.10,000/- on 1st December 2021, you can only redeem it on or after 1 December 2024.

However, the process is a bit different when it comes to SIP investments. For SIPs, you invest a fixed amount every month. Hence, the lock-in period applies to all of your monthly investments individually. Let’s understand this with an example.

Let’s say you invest Rs.1,000/- from January 2022 to April 2022 and you receive 100 units every month from your investment. So, for SIPs, January units can only be redeemed after January 2025 (a lock-in period of 3 years). But this won’t be applicable for other months’ investments. You can redeem February’s units only after February 2025 and so on and so forth.

Also read: What is dividend stripping: Workings & tax implications

ELSS vs Other Tax Saving Instruments

The comparison chart between ELSS and other tax-saving instruments is as follows:

Tax Saving Investment Option	Lock-in Period	Returns
Equity Linked Savings Scheme (ELSS)	3 years	10% to 12%
Public Provident Fund (PPF)	15 years	7% to 8%
Fixed Deposit (FD)	5 years	6% to 7%
National Pension System (NPS)	Till retirement (60 years)	8% to 10%*
National Savings Certificate (NSC)	5 years	7% to 8%

ELSS or SIP – Which Is Better?

Comparing ELSS and SIP is not ideal. This is because these are two crucial but different terminologies associated with mutual fund schemes. While ELSS is an investment scheme, SIP (Systematic Investment Plan) is an investment mode.

The following lists these concepts in more detail:

ELSS

These schemes allocate 80% of their funds in equity, thus falling under the category of equity mutual fund schemes. Such funds offer tax benefits of up to Rs.1.5 lakh under Section 80C.

SIP

A Systematic Investment Plan is an investment mode that enables the investor to invest a sum of his/her preference periodically – monthly, quarterly or annually.

Investors can invest via SIPs in ELSS to receive the maximum benefits. It could help them receive the benefit of systematic tax-saving. It also helps instil financial discipline in them. 

Best ELSS Mutual Funds in 2022 

The table below illustrates the top-performing ELSS mutual funds of 2022:

ELSS Mutual Funds	Features	3-Year Annualised Returns	5-Year Annualised Returns
Navi ELSS Tax Saver Fund- Direct Plan- Growth	NAV: 23.32Expense Ratio: 0.4%AUM: 59.21 crore	17.06%	10.43%
SBI Tax Advantage Fund-Series III-Direct Plan-Growth	NAV: 66.92Expense Ratio: 2.6%AUM: 31.44 crore	38.48%	24.54%
Quant Tax Plan-Direct Plan-Growth	NAV: 276.62Expense Ratio: 0.57%AUM: 1787.29 crore	45.47%	24.41%
SBI Long Term Advantage Fund-Series IV-Direct Plan-Growth	NAV: 33.72Expense Ratio: NilAUM: 181.72 crore	37.72%	22.41%
SBI Long Term Advantage Fund-Series III-Direct Plan-Growth	NAV: 30.30Expense Ratio: NilAUM: 61.93 crore	31.79%	17.33%
Canara Robeco Equity Tax Saver Fund-Direct Plan-Growth	NAV: 129.79Expense Ratio: 0.59%AUM: 4198.40 crore	26.16%	17.39%
Mirae Asset Tax Saver Fund-Direct Plan-Growth	NAV: 34.69Expense Ratio: 0.5%AUM: 13148.39 crore	23.95%	16.49%
Bank of India Tax Advantage Fund-Direct Plan-Growth	NAV: 116.36Expense Ratio: 1.37%AUM: 644.78 crore	29.14%	16.21%
SBI Long Term Advantage Fund-Series II-Direct Plan-Growth	NAV: 30.12Expense Ratio: NilAUM: 33.09 crore	31.07%	15.77%
SBI Long Term Advantage Fund-Series I-Direct Plan-Growth	NAV: 28.71Expense Ratio: NilAUM: 38.77 crore	30.47%	15.10%
IDFC Tax Advantage (ELSS) Fund-Direct Plan-Growth	NAV: 112.70Expense Ratio: 0.74%AUM: 3851.42 crore	26.20%	14.66%

Disclaimer: Mutual Fund investments are subject to market risk, read all scheme-related documents carefully.

Also Read: 10 Best Performing Index Funds That Can Be A Part of Your Portfolio

Factors to Consider Before You Invest in ELSS Mutual Funds

Investment horizon

You must remember that ELSS mutual funds come with a compulsory lock-in period of three years. Therefore, you need to consider your investment duration before the withdrawal. If the scheme allows you to make regular withdrawals, do note that you can only withdraw the money which has exceeded three years from the day you invested. 

This is why you need to be particular about your date of the contribution and investment duration before you invest in ELSS schemes.

Investment objective

If investing in equity is your main objective alongside availing yourself of tax benefits, ELSS tax saving mutual funds are worth considering. That said, if your financial goals are not in line with the scheme, you may consider other options available on the Navi. If you want to unlock the power of passive investing, visit Navi Mutual Fund and explore a host of mutual funds

Expense ratio

The expense ratio refers to the yearly fee that an asset management company (AMC) imposes on investors to finance the expenses of running the fund. This annual maintenance charge has a direct impact on your net returns. Hence, it is vital to consider the expense ratio of the different ELSS mutual funds when comparing them. 

Final Word

Although investing in ELSS tax saving mutual funds gives significant benefits, for example, tax exemption, there are certain risks involved nonetheless. Therefore, it is of utmost importance that you consider several aspects, such as your risk appetite, investment objective, etc., before investing. 

Moreover, you should also take into account the potential market volatility as the consistency and returns of these funds depend on the performance of the stock market.

Frequently Asked Questions

Before you go…

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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.

This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.