Tax saving is one of the most important financial goals for many people. However, choosing the right tax saving instrument can be confusing and overwhelming. There are many options available, such as PPF, NPS, FDs, insurance, etc., but not all of them offer the best returns and flexibility.
If you are looking for a tax saving option that can also help you grow your wealth in the long term, you should consider investing in ELSS funds. ELSS stands for Equity Linked Savings Scheme, and it is a type of mutual fund that invests in equity and equity-related securities.
Benefits Of ELSS funds
- Tax deduction: You can claim a tax deduction of up to Rs 1.5 lakh per year under Section 80C of the Income Tax Act by investing in ELSS funds. This means you can reduce your taxable income and save tax accordingly.
- Higher returns: ELSS funds have the potential to generate higher returns than other fixed-income tax saving instruments, as they invest in the stock market. The historical average return of ELSS funds is around 12-15% per annum, which is much higher than the interest rates offered by PPF, NPS, FDs, etc.
- Shorter lock-in: ELSS funds have a lock-in period of only 3 years, which is the shortest among all the tax saving instruments under Section 80C. This means you can access your money sooner and reinvest it as per your needs.
- SIP option: You can invest in ELSS funds through a systematic investment plan (SIP), which allows you to invest a fixed amount every month or quarter. SIP helps you to save regularly, average out the market fluctuations, and benefit from the power of compounding.
- Diversification: ELSS funds invest in a diversified portfolio of stocks across different sectors, industries, and market capitalizations. This helps to reduce the risk and volatility of your investment and enhance your returns.
What are ELSS funds?
- ELSS funds are a type of mutual fund that invests at least 80% of its assets in equity and equity-related securities. Equity securities are shares or stocks of companies that are listed on the stock exchange. Equity-related securities are derivatives or instruments that derive their value from equity securities, such as futures, options, warrants, etc.
- These are also known as tax saving mutual funds or tax saver funds, as they offer tax benefits under Section 80C of the Income Tax Act. You can claim a deduction of up to Rs 1.5 lakh per year from your gross total income by investing in ELSS funds. This reduces your taxable income and hence your tax liability.
- These funds are managed by professional fund managers who have expertise and experience in the stock market. They select the stocks based on various factors such as growth potential, valuation, financial performance, industry outlook, etc. They also monitor and review the portfolio regularly and make changes as per the market conditions.
- These funds are subject to market risks and may not guarantee any fixed returns. The returns depend on the performance of the underlying stocks and the overall market conditions. The value of your investment may go up or down depending on the fluctuations in the stock prices.
- These funds have a lock-in period of 3 years from the date of investment. This means you cannot withdraw or redeem your units before completing 3 years. However, you can switch or transfer your units from one ELSS fund to another ELSS fund within the same fund house without affecting your lock-in period.
How do ELSS funds work?
ELSS funds work like any other mutual fund. You can invest in them either through lump sum or SIP mode. Lump sum mode means investing a large amount at once. SIP mode means investing a fixed amount at regular intervals, such as monthly or quarterly.
When you invest in an ELSS fund, you get units of the fund at the prevailing net asset value (NAV). NAV is the price per unit of the fund calculated by dividing the total value of the fund’s assets by the number of units outstanding. NAV changes daily based on the movement of the stock prices.
The units that you get are locked-in for 3 years from the date of investment. You cannot sell or redeem them before completing 3 years. However, you can continue to invest more units during this period through lump sum or SIP mode.
After 3 years, your units become free from lock-in and you can withdraw or redeem them at the current NAV. You will get back your principal amount plus any capital appreciation or loss. You can also reinvest your units in the same or another ELSS fund if you wish to.
Taxes applied on returns of ELSS
The returns that you get from ELSS funds are subject to tax as per the following rules:
- Dividend income: If the ELSS fund pays dividends to its investors, the dividend income is tax-free in the hands of the investors. However, the fund house has to pay a dividend distribution tax (DDT) of 10% on the dividends paid.
- Capital gains: If you sell or redeem your units after 3 years, the capital gains are taxed at 10% if they exceed Rs 1 lakh in a financial year. This is known as long-term capital gains (LTCG) tax. However, you can claim the benefit of indexation, which means adjusting the cost of acquisition of your units with inflation, to reduce your taxable capital gains.
How to invest in ELSS funds?
Investing in ELSS funds is very easy and convenient. You can do it online through various platforms, such as Policybazaar, ClearTax, ET Money, ICICI Direct, etc. You just need to follow these simple steps:
- Choose an ELSS fund: You can compare different ELSS funds based on their performance, ratings, risk profile, portfolio composition, expense ratio, etc., and choose the one that suits your risk appetite and return expectations. You can also use online tools like Policybazaar’s [ELSS Calculator] to estimate your returns and tax savings.
- Complete KYC: You need to complete your know-your-customer (KYC) process before investing in any mutual fund. You can do this online by submitting your PAN card, Aadhaar card, address proof, bank details, etc., and verifying them through OTP or biometric authentication.
- Start investing: You can start investing in ELSS funds either through lump sum or SIP mode. You can choose the amount and frequency of your investment as per your convenience and budget. You will receive a confirmation email or SMS once your investment is done.
- Track your investment: You can track the performance of your ELSS fund online through various platforms or apps. You can also download your account statement or annual tax certificate from the fund house’s website or app.
Tips for investing in ELSS funds
Here are some tips that can help you make the most of your ELSS fund investment:
- Start early: The earlier you start investing in ELSS funds, the more time you have to benefit from the power of compounding and the market cycles. You can also save more tax by investing up to Rs 1.5 lakh per year under Section 80C.
- Invest regularly: Investing regularly through SIP mode helps you to save systematically and avoid timing the market. It also helps you to average out the cost of your units and reduce the impact of market volatility.
- Diversify your portfolio: Investing in different ELSS funds across different fund houses, styles, and themes can help you diversify your portfolio and reduce your risk. However, do not invest in too many funds as it may lead to over-diversification and dilute your returns.
- Stay invested for long term: ELSS funds are meant for long-term investment as they have a lock-in period of 3 years and invest in equity securities. Staying invested for longer periods can help you capture the growth potential of the stock market and earn higher returns.
- Review your portfolio periodically: You should review your portfolio periodically to check the performance of your ELSS funds and make changes if required. You should also monitor the tax implications of your investment and plan accordingly.
Conclusion
ELSS funds are one of the best tax saving instruments that can help you save tax and grow your wealth in the long term. They offer higher returns, shorter lock-in, SIP option, and diversification benefits. You can easily invest in ELSS funds online through various platforms and track your investment anytime. However, you should also remember that ELSS funds are subject to market risks and may not guarantee any fixed returns. Therefore, you should invest in them only after understanding your risk profile and financial goals.