ELSS – Everything You Need to Know Before Investing

Vijay Kuppa
Vijay Kuppa

Mutual funds have a host of products, which cater to most of the needs of customers. They not only help spread your wealth across asset classes but also design various investment strategies to boost your chances of making more out of your money. But generating wealth is not the only function that mutual funds serve. They can also help you in the tax saving season as they have an offering for it. The solution is an Equity Linked Saving Scheme (ELSS). In this article, we aim to provide all the answers to all your ELSS related queries and its functioning.

What are ELSS Funds?

An ELSS is an equity-oriented mutual fund scheme, which functions like any other equity fund, except for that it provides tax benefits under the Section 80C of the Income Tax Act. The portfolio of these funds is constructed like a diversified equity fund and revolves around large and mid-cap stocks; some have a small exposure to small caps as well. In this manner, these funds are still positioned to generate alpha and outperform the market with the additional benefit of tax savings.

Why you should invest in ELSS funds?

The primary reason is tax savings. What better way to save taxes than having the ability to partake in a growing stock market?

Of the total amount of Rs 1.5 lakh allowed as tax deductible under section 80C, you can invest the entire amount into ELSS. Do note that you can invest over this limit into this category of funds as there is no cap on overall investment into these funds. However, you would not be able to claim the tax deduction on any amount exceeding the aforesaid limit.

Talking about saving on taxes, investing into ELSS funds can lead to saving taxes up to the tune of tens of thousands of rupees depending on which tax bracket is applicable you.

There is an important consideration that comes along with investing in ELSS funds, though. The invested amount is locked in for three years from the date of investment. For example, an investment made on April 1, 2016, can only be redeemed on April 1, 2019. This is different from a traditional open-ended equity mutual fund where you can redeem your investment whenever you wish to.

But what about Systematic Investment Plan (SIP) investments? How does the three-year lock-in work in that situation?

To understand that, it is important to look at your investment in terms of a number of units instead of the invested amount because eventually, that is what your money buys. So, if you invested Rs 10,000 on April 1, 2016, and continued investing the same amount for the next five months, the entire amount invested (which is Rs 60,000) does not become available for redemption on April 1, 2019. At that time, only those units will be available for redemption which were bought with the first SIP amount.

In the next five months, all units bought with the successive SIP amounts will become available for redemption. In case you wish to redeem the entire investment at one go even after choosing the SIP route, you need to wait for the end of three years after the final SIP amount. In the aforementioned case, that date would be September 1, 2019. You can redeem your entire investment on that date or any other date going forward.

Top 10 ELSS funds of 2019

With a working knowledge about ELSS funds, it is the right juncture to have a look at some of the best performers from the category. The below table details the top 10 performing ELSS funds of 2018-19, their returns over various periods and the associated risk:

Top 10 ELSS funds
S. No.Name of the fund1-Year Returns (In %)3-Year Returns (In %)5-Year Returns (In %)Riskometer
1Axis Long Term Equity Fund-Direct Plan1.9715.5320.84Moderately High
2Aditya Birla Sun Life Tax Relief 96 – Direct Plan-3.9116.9520.40Moderately High
3DSP Tax Saver Fund-Direct Plan-6.9217.0218.30Moderately High
4Mirae Asset Tax Saver Fund-Direct Plan-0.2524.31Moderately High
5IDFC Tax Advantage (ELSS) Fund-Direct Plan-13.3016.3917.36Moderately High
6L&T Tax Advantage Fund-Direct Plan-12.1616.0216.70Moderately High
7HDFC Taxsaver Fund-Direct Plan-11.2015.7614.63Moderately High
8Invesco India Tax Plan – Direct Plan-1.1717.3219.80Moderately High
9Franklin India Taxshield Fund-Direct Plan-3.4313.0917.16Moderately High
10Kotak Tax Saver – Direct Plan-1.3017.3318.92Moderately High
*Returns as on February 14, 2019

How to invest in ELSS funds?

Like other mutual funds, there are multiple ways in which you can invest in ELSS funds. If you wish to invest offline, you can download the form or get it from a registrar or the mutual fund company’s office whose fund you wish to invest in. You can fill the form, attach supporting documents for Know Your Customer (KYC) verification, and provide a cheque for the amount you wish to invest. In case you choose the SIP option, you need to provide post-dated cheques according to the guidelines of the AMC.

In the online route, you can invest via a mutual fund company’s website or use your demat and trading account with a broker if you have one. You can also use one of several web and mobile applications to invest in these funds. Do take a look at the plans that you can invest in while using the services and also the fee charged. You can make payment for the investment via internet banking and even set a SIP using that mode. KYC verification is also done online.

You can also enlist the services of a mutual fund distributor or investment advisor who will get the investment done for you apart from providing their professional opinion on which funds you should invest in.

Benefits of investing in ELSS funds

Choosing ELSS funds to save on taxes opens up the possibility for returns which can be far superior to its other tax saving peers like fixed deposits and government small savings schemes. Since these funds invest in stocks, they carry a higher degree of risk than peers. But they make a great stepping stone towards investing in equities. Low SIP amounts, a professionally managed portfolio, and a lock-in period mean you can give time to your investment to grow and get to see the benefits of equity investing. Apart from potential superior returns, ELSS funds also provide other benefits.

Among tax saving options available to you, ELSS funds have the shortest lock-in period of three years. While the tax saving fixed deposits that bank and post offices offer, along with National Savings Certificates (NSC) have a lock-in period of five years, Public Provident Fund (PPF) matures in 15 years with partial withdrawal allowed only from the seventh year. The relatively recently introduced Sukanya Samriddhi account has an even longer lock-in.

Also, while returns on schemes like PPF are fixed and are in single digits, the returns on ELSS funds, as can be seen from the top 10 funds table displayed earlier in this article, can be in double digits and up to 2 to three times higher.

Though long-term capital gains are now taxed, the rate is set at 10% only if your realized gains in a year exceed Rs 1 lakh. If your fund performs well, you may still score better returns than PPF or other schemes.

But what if after completing the lock-in period, your ELSS fund has barely grown, or in case of a bear market, actually declined in value?

In such a case, you do not have to redeem your investment. Though the lock-in ends in three years, it does not require you to liquidate your holding. You can continue to remain invested in order to wait for the value to increase.

After three years, your ELSS fund becomes open-ended and you can decide whether to withdraw your entire investment or do it in parts. If your fund is doing well, there is no need to sell your holdings; you can remain invested and continue to reap the benefits of efficient fund management.

If, on the other hand, you do feel the need to sell due to consistently poor performance by the fund manager even though the stock market is doing generally well, then you can decide to switch to a different open-ended scheme from the same fund house or give a different ELSS fund a chance.

Though investors do not usually treat them so, ELSS funds can be an excellent wealth generating option. They help you be patient because of the lock-in and make you disciplined towards investing in general, especially if you choose the SIP route. Sometimes, these funds tend to outperform their diversified or multi-cap peers as well. A good ELSS fund can thus play a dual role in your portfolio: that of capital appreciation and helping you save on taxes.

FAQs on ELSS funds

Here are some frequently asked questions (FAQs) on ELSS funds:

Q> What are ELSS funds?

A> Equity Linked Saving Scheme (ELSS) funds are similar to regular diversified equity mutual funds with the added advantage of tax savings under Section 80C of the Income Tax Act.

Q> Is there a lock-in period in ELSS funds?

A> Yes. Your investment is mandatorily locked in for three years from the date of investment.

Q> Is there a limit on investing in ELSS funds in a financial year?

A> There is no limit on investing in these funds. However, you’d be able to avail tax benefits only up to the maximum permissible limit of Rs 1.5 lakh under Section 80C.

Q> Is SIP available as an option to invest in ELSS funds?

A> Yes, you can invest in these funds in a lump sum or via the SIP route. If you invest via SIP, each investment will be locked in for three years from the date of investment.

Q> Do I have to mandatorily redeem after three years? What happens after the lock-in is over?

A> No, you are not required to sell you ELSS fund once the lock-in expires unless you wish to do so. After three years, the fund becomes open-ended and you can wish to redeem your investment in a lump sum or in parts.

Vijay Kuppa
Vijay Kuppa

Vijay co-founded ORO Wealth after 6 years of investment experience in equity and fixed-income markets and was managing a $1.5 bn investment portfolio focused on Indian markets in his previous role at L&T’s Treasury. He has an MBA from IIM Ahmedabad and a degree in Chemical Engineering from IIT Bombay.

  • Avatar
    Viral harshad dadia
    Posted at 12:56h, 16 February Reply

    I wanted clarification regarding FCAT declaration for elss investment from HUF account.

    • gaurav
      Posted at 05:32h, 19 February Reply

      Hello Sir, Please reach us at connect@orowealth.com or call us at +917587305393. We will be more than happy to help you.

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