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ELSS Funds – Advantages & How to invest in ELSS mutual funds

ELSS Funds
elss funds

ELSS funds are the best tax saving investment option. They fall under the diversified equity category as they invest 80% of their assets in equity and equity related instruments. These tax savings mutual funds qualify for tax exemption of INR 1.5 lakh under section 80C of the Income Tax Act, 1961.

What are ELSS Funds?

Equity Linked Saving Schemes (ELSS) are the best tax saving mutual funds. ELSS mutual funds fall under the diversified equity mutual funds category. This equity fund invests at least 80% of its assets in equity and equity-related instruments, part of the corpus is invested in debt as well. ELSS funds provide dual benefits for its investors of capital appreciation and tax saving. ELSS mutual funds come with a lock in period of three years. Investors are allowed to claim tax deductions under Section 80C of the Income Tax Act, 1961 up to Rs. 1.5 lakh in a financial year.

Who Should Invest in ELSS Funds?

Any individual or HUF who wants to save on taxes under section 80C can invest in ELSS mutual funds. ELSS mutual funds have a certain amount of risk attached to them. This is because of the equity exposure in the portfolio. Therefore, ELSS mutual funds are best suited for individuals who understand equity asset class risk. These tax saver funds offer higher returns when compared to other tax saving schemes. Investors should have a long term horizon for their ELSS investments. Among all the asset classes that qualify for tax deduction under Section 80C of the Income Tax Act, ELSS funds have the lowest lock in period.

ELSS funds offer portfolio diversification for its investors. These tax saver funds have dedicated and professional fund managers. Small investors, too, can save taxes by investing in ELSS mutual funds through SIPs. Historical returns of Best ELSS funds have been around 12% or even higher returns.

Advantages of ELSS Mutual Funds

1. Lowest lock In

ELSS mutual funds have the lowest lock in period when compared to all the other investment options like PPF, NPS, and 5 year FD, etc., that qualify for tax deductions under Section 80C. PPF has a lock in period of 15 years. Withdrawal from NPS can be done only after retirement.

2. High Returns

Top ELSS funds have the potential to earn higher returns than other tax saving instruments like PPF or NPS. These high returns are a result of the risk taken by the fund houses by investing in equities. Some best ELSS funds also invest in mid cap companies. These funds can generate higher returns than funds that invest only in large cap companies. However, the risk associated with such funds is higher when compared to other funds.

3. No Upper Limit

There is no maximum limit to the amount an investor can invest in ELSS funds.

4. Tax

Returns from ELSS funds are taxed at 10%.

5. Professional Management

Professional fund managers manage ELSS mutual funds. Therefore, an investor with little or no knowledge about the markets can invest in the best ELSS mutual funds and still get maximum returns. This professional management service helps investors get higher returns compared to other traditional tax saving options.

Options for Investing in the Best ELSS Funds

There are three types of ELSS mutual funds that an investor can choose from,

1. Growth Option

Under the growth option, the investor gets the gains only at the time of redemptions. Appreciation in the total NAV of the ELSS mutual fund multiplies the profits. Investors are not entitled to benefits in the form of dividends. Mutual fund returns are subject to market risks, and so are the returns from ELSS funds.

2. Dividend Option

Under the dividend option, the investor is entitled to get timely dividends. Dividends are declared only when there are excessive profits. According to the budget 2020, the dividends are taxed in the hands of the investors. The investors are supposed to pay the tax on dividends based on their income tax slab.

3. Dividend Reinvestment Option

Under this option, the investor can choose to reinvest dividends received into the same scheme. This option is favorable when the markets are doing well and are likely to continue in the same way.

Upon choosing the type of ELSS fund, the investor can invest either through a lump sum amount or SIPs. ELSS mutual funds are suitable for small investors as well, who wish to invest small and regular amounts to save tax. However, if an investor has a lump sum amount, they can also invest the entire amount in the top ELSS funds.

How to Evaluate the ELSS Mutual Funds?

Evaluating a mutual fund before investing in one is very important. Not every investor is the same, and hence the same fund never suits two different investors. But there are specific rules of thumb that all investors can follow to evaluate mutual funds before investing in them. Below are a few pointers an investor can use.

1. Performance of the fund

The performance of the fund is the first thing any investor checks. While checking the performance of the fund, the current performance and the past performance has to be checked. Its consistency also has to be checked. Investors also have to compare the fund’s performance with that of the benchmark. The more consistent a fund’s performance is, the better the fund is.

2. Fund History

Investors have to check the fund house, its governance, and the number of years of experience it has. The older the fund house and the more experience the fund manager has, the better they will be at handling the fund’s portfolio in all situations.

3. Expense ratio

The expense ratio is the cost an investor incurs for investing in mutual funds. It is calculated as a percentage of the NAV. Hence investors have to make sure the fund has a lower expense ratio. Lower the expense ratio, the higher will be the returns.

4. Taxation

The taxation rules of the fund upon maturity is important. Investors have to understand the tax implications of redeeming their investment in the short and long term.

5. Sharpe Ratio

Sharpe ratio evaluated the return of the fund against the risk. Hence higher the ratio, the better is the fund. The formula is Sharpe ratio = (Average portfolio return − Risk-free rate)/Standard deviation of the portfolio.

6. Standard Deviation

Standard deviation of the fund shows the volatility in a fund’s performance by measuring the degree to which the fund’s return fluctuates around the average return. Lower the standard deviation better it is.

7. Beta

Beta measures the volatility of a fund when compared to the market. A beta higher than one indicates a higher return than the market in the bullish phase but also shows higher lows in the bearish market. A beta of one or less than one is ideal.

8. Alpha

Alpha is the excess return of a fund over its benchmark. Higher the alpha better the fund.

9. R-Squared

It measures how a price change in an asset is correlated to its benchmark. It is reported as a number between 0-100. A high R-squared means a high correlation to the benchmark. A high R-Squared is always better as it assures the fund can earn benchmark returns, if not more.

How to Invest in Best ELSS Funds?

Investing in ELSS funds can be done by online and offline methods. The following are the steps to invest in ELSS funds.

1. Select an ELSS mutual fund that best suits your requirements

Using the above criteria, investors can shortlist the funds that best suit their objectives and are performing better than others in the category.

2. Choose whether you want to invest directly or go with an advisor

Once the funds are shortlisted, the investor has to choose whether they want to invest directly or go with the advisor. If the investor opts to invest directly, then he/she can directly go to the fund house office or go online to the fund houses’ website or any portal that offers direct mutual funds. If the investor wants to invest through a distributor, then they can opt for regular funds.

3. Select a bank account from where you want your investment to be made

The next step is to open a bank account if there is none or select from which bank account the investor will invest. This bank account will be there until the investor wishes to change the bank account with the fund house. Choose a bank account that always has money in it.

4. Select an offline intermediary or an online portal that will help you to invest

The next step is to select an offline intermediary like a financial advisor or mutual fund distributor to invest physically in mutual funds. Or the investor can choose from multiple online portals that have robotic algorithms designed to recommend the funds based on investor profiles.

5. Invest in the fund either through SIP or lumpsum

Once the fund is selected, the bank account is in place, and the intermediary is chosen, the next step is to decide whether to invest in the chosen fund through SIP or lumpsum. If the investor has a lump sum amount available, then he/she can choose to invest a lump sum amount. If they want to invest a certain sum regularly, then they can choose the SIP option. They can finally invest in the fund by following the guidelines of the fund house or the intermediary.

Tax Benefits of ELSS Funds

Investment in ELSS funds qualifies for tax exemption under section 80C of the Income Tax Act 1961. From April 2018, long term capital gains tax (LTCG) of 10% was introduced on equity funds. Hence once the lock in period is completed, and during redemption, the gains (if any and above Rs 1 lakh) are subject to LTCG tax of 10%. The investor can hold the investment in the ELSS funds even after the lock in period of 3 years is completed. But premature withdrawal from the ELSS funds is not allowed.

The dividends distribution tax (DDT) is removed from April 2020, and the dividends are now charged in the hands of the investors based on their income tax slab.

Top ELSS Funds

The best ELSS funds 2020 recommended by Scripbox are,

Frequently Asked Questions on ELSS Funds.

Why invest in ELSS Funds?

ELSS funds qualify for tax exemption under section 80C of the Income Tax Act 1961. Hence investing in ELSS funds is beneficial in two ways for the investor. The investor can save tax on the investment amount as well as save up for long-term as these funds invest majorly in equity, and equity has the potential to earn good returns.

Is the maturity of ELSS Funds taxable or not?

Upon redeeming ELSS funds, if there are any gains, then they are taxed at 10% if the gains exceed one lakh. This 10% is called the Long Term Capital Gains Tax, which has been reintroduced in 2018 by the government of India. ELSS funds are not subject to short term capital gains tax as there is a lock in period of three years.

Which is better ELSS or PPF?

ELSS and PPF, both qualify for tax saving up to INR 1.5 lakhs under Section 80C of Income Tax Act 1961. ELSS has higher volatility as it invests in equity and hence higher returns. PPF has lower volatility and lower returns than ELSS funds as it invests in debt securities. Lock in period in ELSS is three years and in PPF is 15 years. Best ELSS funds have a higher return, and historically they have given close to 15% return and PPF’s returns prefixed by the government of India and the present rating being 7.9%. From all this, we can infer that ELSS funds are a better tax saving investment option for investors.

How much should I invest in ELSS Funds?

Investment from ELSS funds is exempted from tax under Section 80C. The maximum exemption allowed under Section 80C is INR 1,50,000. This exemption includes investment in multiple instruments, including PPF, insurance, etc. An investor can invest the remaining amount in ELSS funds after investing in insurance or any other schemes allowed for deduction under Section 80C.

Is ELSS good for long term investment?

Yes, ELSS funds are considered suitable for the long term. This is because they invest 80% of their assets in equity and equity-related instruments. Equity has the potential to earn a higher return when compared to debt. Hence investing ELSS for the long term can be beneficial for the investor.

Can I withdraw ELSS after 3 years?

Yes, investors can withdraw their investments from ELSS funds after the lock in period of 3 years. In the case of a lump sum investment, the entire amount can be withdrawn after three years. But in the case of SIP investment, each SIP investment has to complete the 3-year term.

Are ELSS gains tax free?

Gains from ELSS aren’t tax-free. They are subject to LTCG gains of 10% if gains are above one lakh.

Does ELSS have a lock in period?

Yes, ELSS funds have a lock in period of 3 years. During this period, the investor cannot withdraw the investment.

Published on December 18, 2019