Mutual funds have long been an investment option and among these, there is a very specific category which offers both wealth creation as well as tax saving called ELSS, which can be said to be one of the dual-benefit generating types of mutual funds that are gaining immense popularity as an investment avenue for many individuals. This article explains what ELSS is, how it works, and why it might be the right investment for tax-conscious investors.
ELSS, or Equity-Linked Savings Scheme, is a type of diversified equity mutual fund. A significant portion of the assets in ELSS is invested in equities, which means it carries market-related risks, but also has the potential for higher returns over the long term. ELSS funds come with a mandatory lock-in period of three years, which means that once invested, the funds cannot be withdrawn before the completion of this period.
Among other tax-saving options available under Section 80C of the Income Tax Act, the three-year lock-in period is one of the shortest, and this is one of the reasons why ELSS is favored by many investors looking for quick liquidity post-lock-in.
ELSS mutual funds are famous for their tax-saving advantages. Investments in ELSS can be eligible for tax deduction up to INR 1.5 lakh under Section 80C of the Income Tax Act. This reduces taxable income, thus saving significant amounts of tax for the investor.
Besides, since the lock-in period offered by ELSS exceeds one year, the accrued profits generated from ELSS investments would be classified under LTCG. So, till date, LTCG derived from investing in equities is free of tax upto INR 1 lac per financial year. The 10% tax rate prevailing for the other investment categories appears higher on these excess amount.
With tax-saving advantages coupled with market-based growth, ELSS funds seem to offer a good proposition for tax savings with the generation of wealth over time.
ELSS competes with a host of other tax-saving instruments such as Public Provident Fund (PPF), National Savings Certificates (NSC), and Tax-saving Fixed Deposits (FDs). However, ELSS is unique in some ways:
Although ELSS may give the potential for better returns, it comes with all the risks that accompany equity markets. The short-term performances of funds may get affected by market volatility. Fixed-income options such as PPF or FD do not offer a guarantee of returns, whereas ELSS does not provide returns. Thus, one should be well aware of the risks involved and assess their financial goals and risk-taking capacity against the volatility of equity markets before investing in ELSS.
As there is lock-in for three years to withdraw the investment, investment decisions should also be supplemented by sufficient liquidity to meet all short-term requirements and weather through the market up and downs.
ELSS mutual funds can, therefore be considered a compelling investment option in search of the combined objectives of tax savings with long term wealth creation. With a short lock-in period, possibility of better returns, and tax benefit under Section 80C, ELSS can become an integral part of the diversified investment portfolio. Like any other market-related investment, it carries risks which must be taken into account. For medium to long-term investment horizon, ELSS could be a wonderful tool for both tax efficiency and financial growth.