Best Equity Linked Savings Scheme | Tax Saving Funds - MF Explorer

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Best ELSS Funds

What is ELSS?

ELSS is short for Equity Linked Savings Schemes and there is a reason why these funds see more inflows, the closer we get to the 31st of March. ELSS funds are a type of mutual fund that get you a deduction under Section 80C of the Income Tax Act. So, investors scurry to invest in ELSS before the financial year ends to get some tax deduction. What’s more, the best ELSS funds can also help you achieve your long term wealth creation goals.

ELSS and Section 80C deduction

Section 80C of the Income Tax Act allows individuals and HUFs to deduct certain eligible investments and expenses from the total income.  This has the effect of reducing the tax payable by reducing the taxable income. Our article shows you how you can use Section 80C most efficiently.  Eligible investments include EPF, PPF, Sukanya Samriddhi Savings Scheme, NSC, Tax saving fixed deposits, NPS, Senior Citizens Savings Scheme, ELSS and payment of insurance premia. Eligible expenses include repayment of principal portion of home loan and tuition fee for two children.  

The aggregate deduction allowed under this section is capped at Rs. 1.5 lakhs covering all the investments and expenses.  What this means is that even if you invest and spend over Rs. 1.5 lakhs on eligible investments and expenses, you can still only claim Rs.1.5 lakh as a deduction.

Further, deductions u/s 80C are only available if individuals have opted for the old regime. If the new tax regime has been opted for, deductions u/s 80C will not be available in exchange for lower tax rates.

ELSS is among the few options (NPS, ULIPs are others) that are linked to market movements and enjoy Section 80C deduction

How does an ELSS fund work?

Like any other mutual fund, one can invest in an ELSS fund by the lump sum route or by the SIP route. One can also choose between the growth or IDCW option. The difference here is that these funds come with a mandatory 3-year lock-in period from the date of allotment of units. If investments have been made via the SIP route, the 3-year lock-in will apply to each installment. Once the 3-year period has lapsed, the units can be redeemed or the investor can (and probably should) stay invested in the fund. There is no cap on how much an investor can invest in ELSS funds in a year but the overall deduction across all eligible investments and expenses will be capped at Rs. 1.5 lakh.

Where do ELSS funds invest?

ELSS funds are primarily equity oriented funds and invest at least 80% of their assets in equity and equity related instruments. They are actively managed and do not come with restrictions on where to invest (for e.g. like large cap funds) and so can invest across large, mid and small cap, at the discretion of the fund manager.

What is the benchmark for ELSS funds?

The benchmark is an index used to measure the fund’s performance and being actively managed, ELSS funds will seek to outperform their index. Different ELSS funds have different benchmark indices but the commonly used ones are S&P BSE 200, S&P BSE 500 TRI, S&P BSE 100 TRI, S&P BSE 200 TRI, BSE Sensex TRI, Nifty 500 TRI, Nifty 200 and Nifty 50 TRI.

 

How are returns from ELSS funds taxed?

If one has picked the IDCW option, any IDCW payout made will be added to the income of the investor and taxed at the applicable slab rate. When units are redeemed, the capital gains (if any) will be taxed. Due to the 3-year lock-in, the question of short term capital gains does not arise. Long term capital gains on ELSS funds, in excess of Rs. 1 lakh will be taxed at 10%.

 How does it compare to other investments eligible u/s 80C?

  • When compared to other eligible investments, ELSS funds come with a shorter lock-in period at 3 years as against the others which are upwards of 5 years. After the 3-year lock-in, an ELSS fund will be like a regular mutual fund.
  • ELSS funds also do not come with fixed or assured returns. On the other hand, they do offer the likelihood of greater returns compared to the other eligible investments (which are more savings avenues geared towards protecting the capital and assuring returns rather than creating wealth).
  • This likelihood of greater returns of course comes with the added risk that goes with all equity and equity related investments, especially in the short to medium term. Most ELSS schemes come with the arrow pointing to ‘Very High’ on the Riskometer. Therefore, like all equity investments, ELSS funds too would do well to be invested in for at least 5 to 7 years to be allowed to perform.

Suitability

  • ELSS funds are ideally suited for investors looking to reduce their tax burden, but at the same time, not wanting to lose sight of their wealth creation goals and equity is the best asset class to create wealth in the long term.
  • Having said that, equity brings with it volatility and the possibility of losses especially in the short to medium term. While ELSS funds come with a lock-in of 3 years, like all equity funds, these too would ideally need to be invested in for at least a 5 to 7-year period to be allowed to perform. Therefore, the money invested in an ELSS fund should not be required in the short term and should only be put away for long term goals.
  • Given the risk level that comes with equity investments, these would be suited for investors with a tolerance for higher than moderate risk levels.
  • The best ELSS funds would make a good portfolio addition for investors starting off on their wealth creation journey and looking to diversify their portfolios into equity.

How to choose the best ELSS funds?

When evaluating funds to pick the best ELSS funds, factors such as investment strategy, expense ratios, performance vis-à-vis peers and benchmark, consistency of performance and volatility would be key parameters to watch.  Take a look at Prime Ratings to see where a fund stands as against its peers on historical quantitative data. Prime Funds removes all the guesswork in identifying the best ELSS funds and recommends three of them that you can consider for your portfolio.

 

General Disclosures and Disclaimers

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