What is an ELSS Fund?
SEBI defines tax savings schemes as funds with a 3-year lock-in on which investors can enjoy a tax deduction on investment. The tax deduction is available under section 80C of the Income Tax Act, 1961.
To put simply, ELSS Funds are a type of mutual fund which helps investors save taxes. An investor can save upto 1.5 lakhs per year under section 80C when investing in an ELSS fund.
One can choose either the growth or the dividend option with ELSS funds. Under the dividend option, the dividend is taxable in your hands and TDS is deducted at 10% (7.5% concession rate up to March 31, 2021).
ELSS funds in India
There are currently 38 ELSS funds in India. Here’s the full table of all the funds and their date of incorporation and their relative 1, 3 & 5 year (3 year rolling) return.
Why ELSS fund?
An ELSS fund has many advantages. The first and main advantage is (ofcourse) :
- Benefits of equity
There are not too many tax-saving options that allow you build wealth using equities. With superior returns over the long term, ELSS can be ideal wealth building vehicles for long-term goals.
- Tax Saving
The biggest advantage of ELSS is the 1.5 lakhs deduction under 80C. Thus it helps save tax and also generate equity returns. The profits while redeeming units (after lock-in) is taxable at 10% (LTCG).
The other advantages of ELSS funds include :
- Lesser lock-in period
When compared to the lock-in period of other tax savings schemes like PPF (15 years), ULIP (5 years) & NPS (until 60 years), ELSS has a MAJOR advantage of only a 3 year lock-in period.
- Longer Outlook
Since ELSS funds have a 3 year lock-in period, the managers of ELSS funds take a slightly longer outlook in terms of their choices and are not constrained by redemption pressure.
- All-Weather Portfolio
Since ELSS funds do not have any market cap restrictions, fund managers typically invest across all 3 categories of large, mid and small caps, the fund acts as a go-anywhere multi-cap fund. In other words fund managers can increase or decrease any of these marke tcap segments based on opportunity and also volatility (when market falls increase large caps and so on)
What type of investor should go for ELSS?
ELSS is more suited if you:
- have a higher risk tolerance
- don’t need cash in the near future (at least 3 years)
- looking to grow their wealth by compounding rather than churning their portfolio frequently
Even though ELSS has a lock-in period of 3 years, it is desirable that you have a minimum of 7+ years as your timeframe; as is the case with any equity product. .Or better still, you can link it to their specific long-term goals.
When should you invest in ELSS? Let’s first see when investors typically invest in ELSS schemes. The table below has the average monthly inflows into ELSS over different months for the last 6 years.
From this table it is evident that most people invest via lumpsum into ELSS funds during the month of March. This is the “last minute rush” of saving tax. Don’t be that guy. Setting up an SIP is a more efficient way of investing in equity funds (ESPECIALLY during a raging bull market).
The lock-in period
ELSS funds have a 3-year lock-in. That means every instalment of SIP you invest is also locked in for 3 years and you cannot redeem the same. So do remember that you will not be able to take out the last instalment’s units until after 3 years from the date of SIP. But should you redeem necessarily after 3 years. Not at all. Read on.
After the lock-in period
You’ve invested in an ELSS fund. You’ve waited 3 years. Now what?
Do you stay invested? Do you switch funds?
The answer to this question is simple. If the fund has delivered superior returns compared to its peers and beaten the index, it’s advisable to remain with the fund as long as you don’t need the money. In other words, if performance is sound and this is part of your long-term portfolio, there is no need to exit. However, if you find your fund lacking in performance then it is a good time to exit and reinvest the same in a good open-ended equity fund instead.
So, What are the best ELSS funds?
There’s a lot of research work that needs to be done when finding the best ELSS funds. You need to look at factors such as:
- Consistency in performance against peer group and benchmark
- Volatility in performance
- Ability to contain downsides in a correction and ability to deliver in bull markets.
- Investment strategy across market cap
- Expense Ratio (the lower, the better)
We have used the above metrics and a lot more, to come up with our ratings on the best ELSS funds. Find them here.
If you want the best ones to invest in, we have further narrowed it to 3 funds that you can invest in. See them here.
How to invest in an ELSS fund?
The process of buying an ELSS fund is similar to that of a normal mutual fund.
You can go ahead and pick literally any broker/distributor or invest directly through the fund’s website. You can always have access to quality, unbiased research and recommendations from PrimeInvestor!