What is ELSS: Meaning, Benefits, and How to Invest

What is an ELSS fund?

ELSS, or Equity-Linked Savings Scheme, is a type of mutual fund that primarily invests in equity markets, i.e., stocks. It combines the potential of offering returns with the added advantage of tax deductions. Simply put, it helps in both wealth creation and offers tax benefits under Section 80C of the Income Tax Act¹. Rather, it is the only mutual fund that does so⁹!

In fact, if we discuss the ELSS fund benefits, one of them is equity exposure. Generally, 80% of the funds are invested in equity and equity-related instruments.² In terms of diversification, ELSS funds invest across sectors and market capitalizations, which eventually spreads the risk. Hence, when you invest in ELSS, your money gets pooled along with other investors’ funds and allocated to equity stocks. Consequently, fund managers manage these investments actively to generate returns.

For example, let’s say you invest ₹1.5 lakh in an ELSS fund today. This amount will be locked for 3 years¹. Over this period, the value of your investment will grow based on market performance. After the lock-in period ends, you can redeem the amount or maybe reinvest it for your long-term goals.
 

Why invest in ELSS?
 

For someone who wishes to invest in mutual funds and save on taxes Here are some ELSS fund benefits that you can expect.
 

1) Tax benefits

This is one of the most practical reasons. Investments in ELSS qualify for tax deductions under Section 80C (in case of old tax regime). This means that by investing ₹1.5 lakh, you can save up to ₹46,800 in taxes annually. ³

2) Wealth creation and higher returns

Since ELSS invests in equities, it offers the potential for  returns than regular tax-saving options like PPF or fixed deposits. Historical data shows that ELSS delivered 12% or more average annual returns over the last 10 years.⁴ Considering all this, ELSS can seem quite ideal for investors who are seeking growth.

3) Short lock-in period

Unlike other tax-saving schemes, such as PPF (15 years) or NSC (5 years), ELSS funds have a lock-in period of just 3 years, which makes them relatively  flexible¹.

4) SIP option available

This is yet another  ELSS fund benefit. You can start investing in ELSS through Systematic Investment Plans (SIP), which allows you to contribute in small amounts regularly.⁵ Not only does this ensure affordability, but it also helps you benefit from rupee cost averaging.

5) Diversified portfolio

ELSS funds can invest in a mix of large-cap, mid-cap, and small-cap stocks.¹⁰ This offers you the opportunity to get a diversified portfolio.

6) Easy to invest and track
 

Investing in ELSS is generally a straightforward process. Monitoring your funds is also easy, as you can track the performance of your fund online.
 

Who should invest in ELSS?

Ideally, ELSS is suitable for:
 

1. First-time investors

ELSS is a starting point if you are new to equity markets but want to explore them while saving taxes.

2. Long-term planners

It is perfect for young professionals or individuals looking to build wealth for long-term goals like funding a higher education, buying a house, or planning retirement.
 

3. Tax savers

ELSS can be considered if you are a salaried individual looking to save taxes while growing your wealth.

4. Risk-tolerant investors

If you are someone who is comfortable with equity market fluctuations.
 

How to invest in ELSS?

Investing in ELSS is quite easy and can be done online or offline. Here’s how to get started:
 

1) Research and compare funds

Try looking for funds with a good performance track record, low expense ratio, and consistent returns over the years.

Tip: Try choosing an industry/ sector/ company that you understand. Intelligent investing relies on evaluating businesses within your circle of competence and understanding your limits.

2) Choose an investment mode:

Here, try choosing between a lump sum (investing a one-time amount) or SIP (investing monthly).⁸

3) Complete KYC:

Complete the mandatory Know Your Customer (KYC) process accurately. Make sure there are no mistakes, as they will only delay the process.

4) Invest through a platform:
 

You can invest via:
 

Mutual fund companies:
 

You can directly invest through the official website or app of a mutual fund company.
 

Brokers or agents:
 

Reach out to financial advisors or distributors to make informed and guided decisions.
 

Online platforms:
 

This is where it gets easy. You can invest in different online investment platforms for hassle-free investing.
 

Banks:
 

Many banks offer ELSS funds through their mutual fund branches.
 

5) Monitor its performance:

While ELSS has a lock-in of 3 years¹, periodically monitoring its performance can help you make better financial decisions.
 

How to choose the best ELSS fund^{11, 12 & 13}?

When selecting an ELSS fund, make sure you consider the following factors:
 

1. Past performance:

Look for funds with a consistent track record of returns over several market cycles.
 

2. Expense ratio:

Funds that come with lower expense ratios can translate to increase in net returns.

3. Fund manager expertise:

Always check the fund manager’s experience and track record.
 

4. Risk tolerance:

This is extremely important. Select a fund that aligns with your risk appetite only (be it aggressive or conservative).

5. Portfolio composition:

Make sure that the fund’s investment strategy aligns well with your financial goals.
 

Things to keep in mind before investing in ELSS

Just knowing what is ELSS is not enough. Here’s what you need to keep in mind before investing in it:

1. Risk appetite

ELSS is a market-linked product. Although it offers returns, it carries risk. Before investing, make sure you understand your comfort with market risks.
 

2. Investment horizon

Although the minimum lock-in is 3 years¹, staying invested for 5 to 7 years can help you get more out of your returns.
 

3. Tax implications

While investments are tax-deductible, the returns are taxed as Long-Term Capital Gains (LTCG) at 12.5% for gains exceeding ₹1.25 lakh.

Bottom line

Summing up, ELSS is an option for anyone looking to save taxes and grow wealth. With their short lock-in period,  return potential, and flexibility, ELSS indeed stands out as one of the best tax-saving options in India. However, it also comes with its own set of risks. The key to getting the best out of this lies in analysing your risk appetite. All in all, make sure you choose your funds wisely, stay informed and updated, and invest for the long term to make the most of this opportunity.